The Economy

Economic data has been mixed since our last newsletter, making it difficult to get a solid read on the state of the economy. The market also appears to be having a difficult time making up its mind, given that the S&P 500 has been essentially drifting sideways over the past two weeks, signaling the summer market doldrums are in full swing.

Retail and food service sales were much weaker than consensus estimates for the month of July. July retail sales was virtually unchanged from the June reading, which was revised upward from +0.6% to +0.8%, according to the latest report from the Census Bureau. Compared to the year-ago period, retail and food service sales were up 2.3%.

Industrial production increased 0.7% in July, according to a new Federal Reserve report. The advance in July was the largest for the index since November 2014 and follows a 0.4% increase in June. Manufacturing output, the largest component of the industrial sector, increased 0.5%, its largest gain since July 2015. The index for utilities rose 2.1% as a result of warmer-than-usual weather in July boosting demand for air condition. Mining output also increased, rising 0.7%. The index has increased modestly, on net, over the past three months after having fallen about 17% between December 2014 and April 2016, according to the Federal Reserve.

Inflation eased in July, as the Consumer Price Index was unchanged, according to the latest report from the Department of Labor. This comes after a 0.2% increase in June. The core Consumer Price Index (which strips out volatile food and energy prices) increased just 0.1% in July, after an increase of 0.2% increase in June. Compared to a year ago, prices are just 0.8% higher, a smaller increase than the 1% rise for the twelve months ending in June. Core prices are 2.2% higher, below the 2.3% year-over-year increase in June.

The housing sector expanded sharply in July, as New Home Sales increased 12.4% in July, according to the Census Bureau. The figure, 654,000, is the strongest pace of new home sales since October 2007 and is up 31.3% where they were a year ago. Median sales prices fell 0.5% to $294,600, which is essentially unchanged from a year ago.

Oil prices have increased, rising to as high as $49 a barrel after a reading two weeks earlier at about $44 a barrel. As of this writing, on August 25th, the price had come off the recent highs and was at roughly $47 a barrel. Regarding gas prices, a gallon of regular unleaded gas, on average, cost $2.20 on August 25, up from $2.16 a month earlier, according to AAA. That's about 15.1% below where it was a year ago.

Since our last newsletter, the S&P 500 returned -0.6%, while the Hot List returned 1.2%. So far in 2016, the portfolio has returned 10.1% vs. 6.3% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 210.2% vs. the S&P's 117.2% gain.

The Fed - Will They or Won't They Raise Rates, And What It Means for Investors

The debate rages on...will the Federal Reserve raise interest rates again before the end of the year? Since the publication of the last Hot List Newsletter, the Federal Reserve released the minutes of its July 26-27 Federal Open Market Committee meeting, during which the committee voted to leave the fed funds rate unchanged. The minutes offered no definitive answer to the "rate-debate," as they noted officials lacked a strong consensus opinion regarding interest rate policy. Specifically, "the Committee would likely have ample time to react if inflation rose more quickly than they currently anticipated, and they preferred to defer another increase in the federal funds rate until they were more confident that inflation was moving close to 2% on a sustained basis."

Looking at various economic data reports in recent weeks provides little firm guidance as to the rate-debate. Employment data implies a near term rate hike is in the cards, as job growth was strong in both June and July, with nonfarm payrolls increasing far above consensus estimates in both months. Other data releases, though, muddy the waters, indicating an economy on less-than-solid footing. For example, retail sales was unchanged for the month of July, warning that the consumer, the key driver of the U.S. economy, has cooled discretionary spending, calling into question whether a rate increase is warranted. A better read on the situation could be provided as of the date of this publication, as Federal Reserve Chairwoman Janet Yellen is set to deliver a speech at the Kansas City Fed's Economic Symposium in Jackson Hole.

However, a firm answer to the question "Will the Fed raise rates or won't they?" may not be provided for weeks, or perhaps months, down the road, as the Fed is scheduled to meet three more times this year -- in September, November and December. And as these future meetings approach, the debate among investors and the news media regarding the next actions of the Fed will likely persist on nearly a daily basis, as long as the U.S. is in the midst of a rate increase cycle.

With this debate comes the discussion of what another interest rate hike, the second in the current rate increase cycle which began in December 2015, would mean for the equity market. Will the 6+ year-long bull market begin to show signs of struggle, or will it continue to rage on? These are questions that have been asked during the early stages of rate increase cycles time and time again. For this piece, I examined research regarding the impact of rising interest rates on the equity market. And, most importantly, address the bottom line: what should an investor do, if anything, in anticipation of additional interest rate increases in the months ahead.

Regarding interest rate hikes and the ensuing performance of the market, I found that no simple answer exists, despite the generalized belief that rising interest rates is a negative event for stocks. In fact, according to a piece published in Forbes in May 2015 by one of the gurus on which I base my investment models, Kenneth Fisher, the Fed raising interest rates is not a problem. In his piece, "Five Market Trends You Can Bank On," he states definitively on interest rate increases, "First, you read so much about it -- so it's largely priced in already. No surprise there. Second, we have a very long history of initial Fed interest rate hikes, and they say simply nothing about future stock returns statistically looking out 30, 90, 180, 360, 1,080 or 1,800 days." With the initial rate hike in the current cycle occurring on December 16, 2015, we are about 250 days in. Thus, according to Fisher's research, no solid conclusions can be drawn regarding what the current rate hike cycle should mean for stock in the coming months, or years, for that matter.

Another piece which discusses the impact of interest rates on the market was published by Ritholtz Wealth Management in July 2014. In it, they examine periods in which there were interest rate changes in either direction and the impact of those changes on the S&P 500. Since we are currently in a rising rate environment, the findings of two of the scenarios are detailed below:

1. Rising stocks, rising rates. According to the piece, their "most significant finding was that when rates were rising, the most prevalent condition for stocks was that share prices were rising too. During a year in which rates rose, 73.9 percent of the time - 34 out of 46 instances - equity prices also moved higher. This combination of events - stocks and rates rising in concert - occurred 39.5 percent of the time." When they examined the environment surrounding periods of rising rates and stocks, Ritholtz Management found "that the average 10-year bond yield was 5.11 percent, the P/E ratio of the S&P 500 averaged about 15, and inflation as measured by the Consumer Price Index (CPI) was over 4 percent. The average S&P 500 increase during these periods was almost 21 percent."

2. Rising rates, falling stocks. "In the dozen instances when rates rose and stocks fell, the S&P 500 lost almost 16 percent on average. At the same time, the 10-year bond yield averaged over 6 percent, the P/E ratio for stocks was a historically low 12.57, but inflation was high, averaging 6.8 percent during these periods. This combination of high rates, hot inflation, and cheap (and getting cheaper) stocks typically implies a recessionary environment."

Their conclusion from this study: "When inflation is high, and rates are going up from already high levels, we see a very negative impact on stocks. When inflation is subdued, and rates start increasing from low or very low levels, the impact on stocks is positive." The current climate is clearly one of rates rising from historically low levels amid a subdued inflationary environment, while the forward 12-month P/E ratio for the S&P 500 is 17.1 (according to FactSet as of the August 18th close). Thus, one may conclude that additional increases in interest rates should not represent a death blow for the current bull market, given the current environment.

A similar conclusion was reached in a study by TIAA-CREF published in the Fall of 2015, in that the impact of rising interest rates depends largely on market circumstances. The study looked at past rate tightening cycles and along with variables similar to those in the Ritholtz piece -- interest rates, inflation rates, rate trends and valuations.

The study notes that "in general, hikes aimed at slowing high or rising inflation tended to hurt stocks. Hikes that rose at a measured pace-or reflected improving economic growth-tended to be more positive. Thus, today's environment of firming growth and modest inflation would tend to be relatively supportive of equities. Although history shows that stocks often stall three months into the cycle, a series of rapid and sustained rate hikes is usually a prerequisite for derailing equity performance."

The market environment in which a rate hike is taking place was also a key factor the investment methodology of another guru on whom I base my investment models, Martin Zweig. Zweig's book, "Winning on Wall Street," published in 1986, includes a chapter entitled "Monetary Indicators -- Don't Fight the Fed." Zweig performed extensive research on the stock market and interest rates and, in the process, developed the Prime Rate Indicator. The prime rate is the rate banks charge their best customers and, according to Zweig, "the beauty of using the prime rate as a stock market indicator is that it does not change every day as do other interest rates." He also favored its tendency to lag behind other interest rates. In "Winning on Wall Street" Zweig states, "An interest rate that moves a little behind other interest rates can often mark just that point when stocks finally begin to respond to the changes in interest rates."

In general, Zweig's work found that rising rates tended to be bearish for stocks and falling rates bullish. But, there was a qualifier: the level of the prime rate. A prime rate above 8% was considered to be relatively high, and below 8% is relatively low. Zweig notes "minor increases in rates at levels above the 'high' 8% zone are enough to give bearish signals for stocks. But at levels below 8%, somewhat larger increases in rates are needed to give bearish signals." At present the prime rate is 3.5%. Thus, rising rates in the current market environment would not have called for an immediate sell signal according to Zweig's Prime Rate Indicator. However, I should go on further to note that if the prime rate is below 8%, Zweig's system does call for a sell signal on the second of two hikes in the rate or on a full 1% jump. Thus, another rate hike by the Fed in the coming months would likely call for a sell signal using Zweig's methodology.

So despite the conclusion from the two aforementioned studies that the level of interest rates matters in a rake hike tightening cycle, all is not cut and dry when it comes to rising rates and the performance, or expected performance, of the equity market. Zweig's research showed that the second rate increase even in a low rate environment is enough to trigger a sell signal, while other research indicates a slow and steady increase in an effort to normalize the level of interest rates, rather than cool off an overheated economy and tame inflation, leaves room for further gains in the current bull market, calling for remaining invested.

If I had dug further into analysis available on the market and changes in interest rates, I'm sure I could have found dozens of other theories and disciplines to offer in this newsletter as potential outcomes to a cycle of rising interest rates, some supporting conventional wisdom that rising rates are bad for stocks. Period.

So, the all-important question that begs answering remains: "What action should investors take in the current stage of the rising rate cycle, particularly if another increase in rates is on the horizon for 2016?" Clearly offering a sweeping suggestion regarding stock allocation would be misplaced, given my longer-term approach of seeking out undervalued stocks of solid companies, regardless of economic conditions or, more specifically, the actions of the Federal Reserve and what that might mean for the market. What I can suggest, though, is study the fundamentals and stay with those companies that offer exceptional value. Abandoning your discipline and adopting a "sell everything" mindset in fear of what may be coming down the pike in regard to interest rates could cause you to miss out on many excellent investment opportunities that appreciate in value irrespective interest rate policy.


The Fallen

As we rebalance the Validea Hot List, 7 stocks leave our portfolio. These include: Nic Inc. (EGOV), Natural Health Trends Corp. (NHTC), Insteel Industries Inc (IIIN), Cal-maine Foods Inc (CALM), Hawaiian Holdings, Inc. (HA), Paycom Software Inc (PAYC) and Anika Therapeutics Inc (ANIK).

The Keepers

3 stocks remain in the portfolio. They are: Valero Energy Corporation (VLO), Banco Macro Sa (Adr) (BMA) and Lgi Homes Inc (LGIH).

The New Additions

We are adding 7 stocks to the portfolio. These include: John B. Sanfilippo & Son, Inc. (JBSS), Polaris Industries Inc. (PII), Supreme Industries, Inc. (STS), Trex Company, Inc. (TREX), Grupo Financiero Galicia S.a. (Adr) (GGAL), Amtrust Financial Services Inc (AFSI) and Banc Of California Inc (BANC).

Latest Changes

Additions  
JOHN B. SANFILIPPO & SON, INC. JBSS
POLARIS INDUSTRIES INC. PII
SUPREME INDUSTRIES, INC. STS
TREX COMPANY, INC. TREX
GRUPO FINANCIERO GALICIA S.A. (ADR) GGAL
AMTRUST FINANCIAL SERVICES INC AFSI
BANC OF CALIFORNIA INC BANC
Deletions  
NIC INC. EGOV
NATURAL HEALTH TRENDS CORP. NHTC
INSTEEL INDUSTRIES INC IIIN
CAL-MAINE FOODS INC CALM
HAWAIIAN HOLDINGS, INC. HA
PAYCOM SOFTWARE INC PAYC
ANIKA THERAPEUTICS INC ANIK

Newcomers to the Validea Hot List

Amtrust Financial Services Inc. (AFSI): Amtrust Financial Services, Inc. (AmTrust) is an insurance holding company. The Company, through its subsidiaries, provides specialty property and casualty insurance focusing on workers' compensation and commercial package coverage for small business, specialty risk and extended warranty coverage, and property and casualty coverage for middle market business. Its segments include Small Commercial Business, Specialty Risk and Extended Warranty, and Specialty Program. The Small Commercial Business segment is engaged in providing workers' compensation, commercial package and other commercial insurance lines produced by wholesale agents, retail agents and brokers in the United States. The Specialty Risk and Extended Warranty segment is engaged in providing coverage for consumer and commercial goods and custom designed coverages. The Specialty Program segment is engaged in writing commercial insurance for defined classes of insureds through general and other wholesale agents.

AmTrust ($4.393 billion market cap) has taken in more than $5.1 billion in sales over the past year. My Peter Lynch-, Warren Buffett-, and Martin Zweig-inspired models are high on its shares. For details about its fundamentals, see the "Detailed Stock Analysis" section.

Banc of California, Inc. (BANC): Banc of California, Inc. is a financial holding company. The Company is the parent of Banc of California, National Association (the Bank) and The Palisades Group, LLC (The Palisades Group). The Company operates through Commercial Banking; Mortgage Banking; Financial Advisory, and Corporate/Other segments. The business of the Commercial Banking segment consists of attracting deposits and investing these funds primarily in commercial, consumer and real estate secured loans. The business of the Mortgage Banking segment is originating conforming single-family residential (SFR) loans and selling these loans in the secondary market. The business of the Financial Advisory segment is operated by The Palisades Group and provides services of purchase, sale and management of SFR mortgage loans. The Corporate/Other segment includes the holding company. The Corporate/Other segment engages in business activities through the sale of other real estate owned and loans held at the holding company.

Banc of California ($1.106 billion market cap) gets an 89% score from my Validea Momentum Investor model and receives high marks from my Peter Lynch- and Motley Fool-based models. Scroll down to the "Detailed Stock Analysis" section to learn more about the stock.

Grupo Financiero Galicia S.A. (ADR) (GGAL): Grupo Financiero Galicia S.A. (Grupo Financiero Galicia) is a financial services holding company. The Company's segments include Banking, Regional Credit Cards, CFA, Insurance and Other Grupo Galicia Businesses. Banco de Galicia y Buenos Aires S.A. (Banco Galicia) is a subsidiary of the Company. Its banking business segment represents Banco Galicia consolidated line by line with Banco Galicia Uruguay S.A. (Galicia Uruguay). It operates the regional credit cards segment through Tarjetas Regionales S.A. and its subsidiaries. Its CFA business segment extends unsecured personal loans to low and middle-income segments of the Argentine population. The Company operates the insurance segment through Sudamericana Holding S.A. and its subsidiaries. Its Other Grupo Galicia Businesses segment includes the results of Galicia Warrants S.A., Galicia Administradora de Fondos S.A. Sociedad Gerente de Fondos Comunes de Inversion and Net Investment S.A.

Grupo Financiero Galicia S.A. ($3.115 billion market cap) gets a 100% score from my James O'Shaughnessy-based model and also earns high marks from my Peter Lynch- and David Dreman-based models. Scroll down to the "Detailed Stock Analysis" section to learn more about the stock.

John B. Sanfilippo & Son, Inc. (JBSS): John B. Sanfilippo & Son, Inc. is a processor and distributor of peanuts, pecans, cashews, walnuts, almonds and other nuts. The Company offers nuts under a range of private brands and under the Fisher, Orchard Valley Harvest, Fisher Nut Exactly and Sunshine Country brand names. The Company also markets and distributes a diverse product line of food and snack products, including snack mixes, salad toppings, snacks, snack bites, trail mixes, dried fruit, and chocolate and yogurt coated products under private brands and brand names. The Company's principal products are raw and processed nuts. The Company's nut product line includes black walnuts, English walnuts, macadamia nuts, pistachios, pine nuts, Brazil nuts and filberts. The Company's products are sold through various distribution channels to buyers of nuts, including food retailers, commercial ingredient users, contract packaging customers and international customers.

John B. Sanfilippo & Son, Inc. ($508 million market cap) has a Price/Earnings/Growth Ratio of 0.46, which is considered very favorable and helps the company earn a high mark from my Peter Lynch-inspired model. My Kenneth Fisher-based model is also high on its shares. For details about its fundamentals, see the "Detailed Stock Analysis" section.

Supreme Industries, Inc. (STS): Supreme Industries, Inc. (Supreme) is a manufacturer of specialized vehicles, including truck bodies, trolleys and specialty vehicles. The Company operates through two segments, which include specialized commercial vehicles and fiberglass products. The Company manufactures specialized commercial vehicles that are attached to a truck chassis. The Company's truck bodies are offered in aluminum, FiberPanel PW, FiberPanel HC, or SignaturePlate. The Company's products include Signature van bodies, Iner-City cutaway van bodies, Spartan service bodies, Spartan cargo vans, Kold King insulated van bodies, stake bodies, armored sport utility vehicles (SUVs), armored trucks and specialty vehicles, and trolleys. Its products are attached to light-duty truck chassis and medium-duty truck chassis. Supreme integrates a range of options into its truck bodies, including liftgates, cargo-handling equipment, customized doors, special bumpers, ladder racks and refrigeration equipment.

Supreme Industries, Inc. ($273 million market cap) scores highly in my Peter Lynch-based model and also earns a high score in my Validea Momentum Investor model, which likes STS's increasing relative strength trend. Scroll down to the "Detailed Stock Analysis" section to learn more about the stock.

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

Trex Company ($1,821 billion market cap) scores highly in my Validea Momentum Investor model as well as in my Motley Fool-based model. The Motley Fool-based model likes the company's profit margin and its relative strength reading of 90. For details about its fundamentals, see the "Detailed Stock Analysis" section.

Polaris Industries, Inc. (PII): Polaris Industries Inc. (Polaris) designs, engineers and manufactures off-road vehicles (ORV), including all-terrain vehicles (ATV) and side-by-side vehicles for recreational and utility use, snowmobiles, motorcycles and global adjacent markets vehicles, together with the related parts, garments and accessories. The Company's segments are ORV/Snowmobiles, Motorcycles and Global Adjacent Markets. These products are sold through dealers and distributors located in the United States, Canada, Western Europe, Australia and Mexico. Its ORVs include Sportsman ATVs, Polaris ACE, RANGER, RZR and Polaris GENERAL side-by-side vehicles. It produces snowmobiles, ranging from youth models to utility and economy models to performance and competition models. Its Motorcycles segment consists of Victory, Indian motorcycles and the moto-roadster, Slingshot. It offers products in the light-duty hauling, people mover and urban/suburban commuting sub-sectors of the Work and Transportation industry.

Polaris Industries Inc. (5.874 billion market cap) earns a score of 100 from my Warren Buffett-inspired investment model. The company is also favored highly by my Peter Lynch-based model. The company's EPS growth rate of 20.5% is considered very good. To read more about its fundamentals, check out the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Banco Macro SA (ADR) (BMA): BMA reported second quarter profit of $127 million on August 9th. The Buenos Aires, Argentina-based bank said it had earnings of $2.17 per share. The financial holding company posted revenue of $318.8 million in the period.

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 my investment strategies. If you have any questions, please feel free to contact us at hotlist@validea.com.

Portfolio Holdings
Ticker Date Added Return
GGAL 8/26/2016 TBD
BMA 7/1/2016 9.0%
VLO 6/3/2016 -0.2%
AFSI 8/26/2016 TBD
LGIH 7/1/2016 8.5%
BANC 8/26/2016 TBD
PII 8/26/2016 TBD
STS 8/26/2016 TBD
TREX 8/26/2016 TBD
JBSS 8/26/2016 TBD


Guru Analysis
Disclaimer: The analysis is from Validea's selection and interpretation of content from the guru's book or published writings, and is not from nor endorsed by the guru. See Full Disclaimer

GGAL   |   BMA   |   VLO   |   AFSI   |   LGIH   |   BANC   |   PII   |   STS   |   TREX   |   JBSS   |  

GRUPO FINANCIERO GALICIA S.A. (ADR)

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

Grupo Financiero Galicia S.A. (Grupo Financiero Galicia) is a financial services holding company. The Company's segments include Banking, Regional Credit Cards, CFA, Insurance and Other Grupo Galicia Businesses. Banco de Galicia y Buenos Aires S.A. (Banco Galicia) is a subsidiary of the Company. Its banking business segment represents Banco Galicia consolidated line by line with Banco Galicia Uruguay S.A. (Galicia Uruguay). It operates the regional credit cards segment through Tarjetas Regionales S.A. and its subsidiaries. Its CFA business segment extends unsecured personal loans to low and middle-income segments of the Argentine population. The Company operates the insurance segment through Sudamericana Holding S.A. and its subsidiaries. Its Other Grupo Galicia Businesses segment includes the results of Galicia Warrants S.A., Galicia Administradora de Fondos S.A. Sociedad Gerente de Fondos Comunes de Inversion and Net Investment S.A.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (11.52) relative to the growth rate (35.54%), based on the average of the 3, 4 and 5 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for GGAL (0.32) is very favorable.


SALES AND P/E RATIO: PASS

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth high enough to support a P/E above this threshold. GGAL, whose sales are $1,708.6 million, needs to have a P/E below 40 to pass this criterion. GGAL's P/E of (11.52) is considered acceptable.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for GGAL is 35.5%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is considered 'OK'. However, it may be difficult to sustain such a high growth rate.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

GGAL is a financial company so debt to equity rules are not applied to determine the company's financial soundness.


EQUITY/ASSETS RATIO: PASS

This methodology uses the Equity/Assets Ratio as a way to determine a financial intermediary's health, as it is a better measure than the Debt/Equity Ratio. GGAL's Equity/Assets ratio (9.00%) is healthy and above the minimum 5% this methodology looks for, thus passing the criterion.


RETURN ON ASSETS: PASS

This methodology uses Return on Assets as a way to measure a financial intermediary's profitability. GGAL's ROA (3.34%) is above the minimum 1% that this methodology looks for, thus passing the criterion.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for GGAL (24.81%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for GGAL (-28.73%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.

BANCO MACRO SA (ADR)

Strategy: Growth Investor
Based on: Martin Zweig

Banco Macro S.A. (the Bank) is a bank. The Bank offers traditional bank products and services to companies, including those operating in regional economies, as well as to individuals. The Bank offers savings and checking accounts, credit and debit cards, consumer finance loans (including personal loans), mortgage loans, automobile loans, overdrafts, credit-related services, home and car insurance coverage, tax collection, utility payments, automatic teller machines (ATMs) and money transfers. The Bank offers Plan Sueldo payroll services, lending, corporate credit cards, mortgage finance, transaction processing and foreign exchange. The Bank offers transaction services to its corporate customers, such as cash management, customer collections, payments to suppliers, payroll administration, foreign exchange transactions, foreign trade services, corporate credit cards and information services, such as its Datanet and Interpymes services.


P/E RATIO: PASS

The P/E of a company must be greater than 5 to eliminate weak companies, but not more than 3 times the current Market P/E because the situation is much too risky, and never greater than 43. BMA's P/E is 11.14, based on trailing 12 month earnings, while the current market PE is 15.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: PASS

Revenue Growth must not be substantially less than earnings growth. For earnings to continue to grow over time they must be supported by a comparable or better sales growth rate and not just by cost cutting or other non-sales measures. BMA's revenue growth is 42.07%, while it's earnings growth rate is 43.98%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, BMA passes this criterion.


SALES GROWTH RATE: FAIL

Another important issue regarding sales growth is that the rate of quarterly sales growth is rising. To evaluate this, the change from this quarter last year to the present quarter (48.2%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (80.2%) of the current year. Sales growth for the prior must be greater than the latter. For BMA this criterion has not been met and fails this test.


The earnings numbers of a company should be examined from various different angles. Three of these angles are stability in the trend of earnings, earnings persistence, and earnings acceleration. To evaluate stability, the stock has to pass the following four criteria.


CURRENT QUARTER EARNINGS: PASS

The first of these criteria is that the current EPS be positive. BMA's EPS ($2.08) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. BMA's EPS for this quarter last year ($0.13) pass this test.


POSITIVE EARNINGS GROWTH RATE FOR CURRENT QUARTER: PASS

The growth rate of the current quarter's earnings compared to the same quarter a year ago must also be positive. BMA's growth rate of 1,500.00% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: PASS

Compare the earnings growth rate of the previous three quarters with long-term EPS growth rate. Earnings growth in the previous 3 quarters should be at least half of the long-term EPS growth rate. Half of the long-term EPS growth rate for BMA is 21.99%. This should be less than the growth rates for the 3 previous quarters, which are 228.57%, 23.08%, and 110.00%. BMA passes this test, which means that it has good, reasonably steady earnings.


This strategy looks at the rate which earnings grow and evaluates this rate of growth from different angles. The 4 tests immediately following are detailed below.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN PRIOR 3 QUARTERS: PASS

If the growth rate of the prior three quarter's earnings, 100.00%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 1,500.00%, (versus the same quarter one year ago) then the stock passes.


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

The EPS growth rate for the current quarter, 1,500.00% must be greater than or equal to the historical growth which is 43.98%. BMA would therefore pass this test.


EARNINGS PERSISTENCE: PASS

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. BMA, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.14, 0.18, 0.28, 0.41 and 0.58, passes this test.


LONG-TERM EPS GROWTH: PASS

One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. BMA's long-term growth rate of 43.98%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes this test.

VALERO ENERGY CORPORATION

Strategy: Value Investor
Based on: Benjamin Graham

Valero Energy Corporation (Valero), through Valero Energy Partners LP (VLP), owns, operates, develops and acquires crude oil and refined petroleum products pipelines, terminals, and other transportation and logistics assets. The Company operates in two segments: refining and ethanol. Its refining segment includes refining and marketing operations in the United States, Canada, the United Kingdom, Aruba and Ireland. Its ethanol segment includes ethanol and marketing operations in the United States. VLP's assets include crude oil and refined petroleum products pipeline and terminal systems in the United States Gulf Coast and the United States Mid-Continent regions. Its refineries can produce conventional gasolines, premium gasolines, gasoline meeting the specifications of the California Air Resources Board (CARB), diesel, low-sulfur diesel, ultra-low-sulfur diesel, CARB diesel, other distillates, jet fuel, asphalt, petrochemicals, lubricants and other refined products.


SECTOR: PASS

VLO is neither a technology nor financial Company, and therefore this methodology is applicable.


SALES: PASS

The investor must select companies of "adequate size". This includes companies with annual sales greater than $340 million. VLO's sales of $76,654.0 million, based on trailing 12 month sales, pass this test.


CURRENT RATIO: FAIL

The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. VLO's current ratio of 1.87 fails the test.


LONG-TERM DEBT IN RELATION TO NET CURRENT ASSETS: PASS

For industrial companies, long-term debt must not exceed net current assets (current assets minus current liabilities). Companies that meet this criterion display one of the attributes of a financially secure organization. The long-term debt for VLO is $6,646.0 million, while the net current assets are $7,528.0 million. VLO passes this test.


LONG-TERM EPS GROWTH: FAIL

Companies must increase their EPS by at least 30% over a ten-year period and EPS must not have been negative for any year within the last 5 years. EPS for VLO were negative within the last 5 years and therefore the company fails this criterion.


P/E RATIO: PASS

The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be "moderate", which this methodology states is not greater than 15. Stocks with moderate P/Es are more defensive by nature. VLO's P/E of 8.89 (using the current PE) passes this test.


PRICE/BOOK RATIO: PASS

The Price/Book ratio must also be reasonable. That is, the Price/Book multiplied by P/E cannot be greater than 22. VLO's Price/Book ratio is 1.24, while the P/E is 8.89. VLO passes the Price/Book test.

AMTRUST FINANCIAL SERVICES INC

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

Amtrust Financial Services, Inc. (AmTrust) is an insurance holding company. The Company, through its subsidiaries, provides specialty property and casualty insurance focusing on workers' compensation and commercial package coverage for small business, specialty risk and extended warranty coverage, and property and casualty coverage for middle market business. Its segments include Small Commercial Business, Specialty Risk and Extended Warranty, and Specialty Program. The Small Commercial Business segment is engaged in providing workers' compensation, commercial package and other commercial insurance lines produced by wholesale agents, retail agents and brokers in the United States. The Specialty Risk and Extended Warranty segment is engaged in providing coverage for consumer and commercial goods and custom designed coverages. The Specialty Program segment is engaged in writing commercial insurance for defined classes of insureds through general and other wholesale agents.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (9.33) relative to the growth rate (27.39%), based on the average of the 3, 4 and 5 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for AFSI (0.34) is very favorable.


SALES AND P/E RATIO: PASS

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth high enough to support a P/E above this threshold. AFSI, whose sales are $5,136.9 million, needs to have a P/E below 40 to pass this criterion. AFSI's P/E of (9.33) is considered acceptable.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for AFSI is 27.4%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is acceptable.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

AFSI is a financial company so debt to equity rules are not applied to determine the company's financial soundness.


EQUITY/ASSETS RATIO: PASS

This methodology uses the Equity/Assets Ratio as a way to determine a financial intermediary's health, as it is a better measure than the Debt/Equity Ratio. AFSI's Equity/Assets ratio (15.00%) is extremely healthy and above the minimum 5% this methodology looks for, thus passing the criterion.


RETURN ON ASSETS: PASS

This methodology uses Return on Assets as a way to measure a financial intermediary's profitability. AFSI's ROA (2.73%) is above the minimum 1% that this methodology looks for, thus passing the criterion.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for AFSI (16.06%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for AFSI (-6.58%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.

LGI HOMES INC

Strategy: Growth Investor
Based on: Martin Zweig

LGI Homes, Inc. is a homebuilder. The Company is engaged in the design, construction, marketing and sale of new homes in markets in Texas, Arizona, Florida, Georgia, New Mexico, South Carolina, North Carolina, Colorado, Washington and Tennessee. The Company has five segments: the Texas division, the Southwest division, the Southeast division, the Florida division and the Northwest division. The Texas division includes homebuilding operations in Houston, Dallas/Fort Worth, San Antonio and Austin locations. The Southwest division includes homebuilding operations in Phoenix, Tucson, Albuquerque, Denver and Colorado Springs locations. The Southeast division includes homebuilding operations in Atlanta, Charlotte and Nashville locations. The Florida division includes homebuilding operations in Tampa, Orlando, Fort Myers and Jacksonville locations. The Northwest division includes homebuilding operations in Seattle location. Its product offerings include entry-level homes and move-up homes.


P/E RATIO: PASS

The P/E of a company must be greater than 5 to eliminate weak companies, but not more than 3 times the current Market P/E because the situation is much too risky, and never greater than 43. LGIH's P/E is 11.85, based on trailing 12 month earnings, while the current market PE is 15.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: PASS

Revenue Growth must not be substantially less than earnings growth. For earnings to continue to grow over time they must be supported by a comparable or better sales growth rate and not just by cost cutting or other non-sales measures. LGIH's revenue growth is 94.39%, while it's earnings growth rate is 81.68%, based on the average of the 3 and 4 year historical eps growth rates. Therefore, LGIH passes this criterion.


SALES GROWTH RATE: PASS

Another important issue regarding sales growth is that the rate of quarterly sales growth is rising. To evaluate this, the change from this quarter last year to the present quarter (40.2%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (34.6%) of the current year. Sales growth for the prior must be greater than the latter. For LGIH this criterion has been met.


The earnings numbers of a company should be examined from various different angles. Three of these angles are stability in the trend of earnings, earnings persistence, and earnings acceleration. To evaluate stability, the stock has to pass the following four criteria.


CURRENT QUARTER EARNINGS: PASS

The first of these criteria is that the current EPS be positive. LGIH's EPS ($0.96) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. LGIH's EPS for this quarter last year ($0.66) pass this test.


POSITIVE EARNINGS GROWTH RATE FOR CURRENT QUARTER: PASS

The growth rate of the current quarter's earnings compared to the same quarter a year ago must also be positive. LGIH's growth rate of 45.45% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: PASS

Compare the earnings growth rate of the previous three quarters with long-term EPS growth rate. Earnings growth in the previous 3 quarters should be at least half of the long-term EPS growth rate. Half of the long-term EPS growth rate for LGIH is 40.84%. This should be less than the growth rates for the 3 previous quarters, which are 123.53%, 111.76%, and 72.73%. LGIH passes this test, which means that it has good, reasonably steady earnings.


This strategy looks at the rate which earnings grow and evaluates this rate of growth from different angles. The 4 tests immediately following are detailed below.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN PRIOR 3 QUARTERS: PASS

If the growth rate of the prior three quarter's earnings, 102.97%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 45.45%, (versus the same quarter one year ago) then the stock fails, with one exception: if the growth rate in earnings between the current quarter and the same quarter one year ago is greater than 30%, then the stock would pass. The growth rate over this period for LGIH is 45.5%, and it would therefore pass this test.


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

The EPS growth rate for the current quarter, 45.45% must be greater than or equal to the historical growth which is 81.68%. Since this is not the case LGIH would therefore fail this test.


EARNINGS PERSISTENCE: PASS

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. LGIH, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.17, 0.50, 1.07, 1.33 and 2.44, passes this test.


LONG-TERM EPS GROWTH: PASS

One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. LGIH's long-term growth rate of 81.68%, based on the average of the 3 and 4 year historical eps growth rates, passes this test.


TOTAL DEBT/EQUITY RATIO: FAIL

A final criterion is that a company must not have a high level of debt. A high level of total debt, due to high interest expenses, can have a very negative effect on earnings if business moderately turns down. If a company does have a high level, an investor may want to avoid this stock altogether. LGIH's Debt/Equity (111.05%) is considered high relative to its industry (51.81%) and fails this test.


INSIDER TRANSACTIONS: PASS

A factor that adds to a stock's attractiveness is if insider buy transactions number 3 or more, while insider sell transactions are zero. Zweig calls this an insider buy signal. For LGIH, this criterion has not been met (insider sell transactions are 59, while insiders buying number 33). Despite the fact that insider sells out number insider buys for this company, Zweig considers even one insider buy transaction enough to prevent an insider sell signal, therefore there is not an insider sell signal and the stock passes this criterion.

BANC OF CALIFORNIA INC

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

Banc of California, Inc. is a financial holding company. The Company is the parent of Banc of California, National Association (the Bank) and The Palisades Group, LLC (The Palisades Group). The Company operates through Commercial Banking; Mortgage Banking; Financial Advisory, and Corporate/Other segments. The business of the Commercial Banking segment consists of attracting deposits and investing these funds primarily in commercial, consumer and real estate secured loans. The business of the Mortgage Banking segment is originating conforming single-family residential (SFR) loans and selling these loans in the secondary market. The business of the Financial Advisory segment is operated by The Palisades Group and provides services of purchase, sale and management of SFR mortgage loans. The Corporate/Other segment includes the holding company. The Corporate/Other segment engages in business activities through the sale of other real estate owned and loans held at the holding company.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (15.32) relative to the growth rate (39.55%), based on the average of the 3 and 5 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for BANC (0.39) is very favorable.


SALES AND P/E RATIO: NEUTRAL

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth rate high enough to support a P/E above this threshold. BANC, whose sales are $319.6 million, is not considered large enough to apply the P/E ratio analysis. However, an investor can analyze the P/E ratio relative to the EPS growth rate.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for BANC is 39.5%, based on the average of the 3 and 5 year historical eps growth rates, which is considered 'OK'. However, it may be difficult to sustain such a high growth rate.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

BANC is a financial company so debt to equity rules are not applied to determine the company's financial soundness.


EQUITY/ASSETS RATIO: PASS

This methodology uses the Equity/Assets Ratio as a way to determine a financial intermediary's health, as it is a better measure than the Debt/Equity Ratio. BANC's Equity/Assets ratio (9.00%) is healthy and above the minimum 5% this methodology looks for, thus passing the criterion.


RETURN ON ASSETS: FAIL

This methodology uses Return on Assets as a way to measure a financial intermediary's profitability. BANC's ROA (0.96%) is below the minimum 1% that this methodology looks for, thus failing the criterion.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for BANC (-18.87%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for BANC (-15.21%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.

POLARIS INDUSTRIES INC.

Strategy: Patient Investor
Based on: Warren Buffett

Polaris Industries Inc. (Polaris) designs, engineers and manufactures off-road vehicles (ORV), including all-terrain vehicles (ATV) and side-by-side vehicles for recreational and utility use, snowmobiles, motorcycles and global adjacent markets vehicles, together with the related parts, garments and accessories. The Company's segments are ORV/Snowmobiles, Motorcycles and Global Adjacent Markets. These products are sold through dealers and distributors located in the United States, Canada, Western Europe, Australia and Mexico. Its ORVs include Sportsman ATVs, Polaris ACE, RANGER, RZR and Polaris GENERAL side-by-side vehicles. It produces snowmobiles, ranging from youth models to utility and economy models to performance and competition models. Its Motorcycles segment consists of Victory, Indian motorcycles and the moto-roadster, Slingshot. It offers products in the light-duty hauling, people mover and urban/suburban commuting sub-sectors of the Work and Transportation industry.

STAGE 1: "Is this a Buffett type company?"

A bedrock principle for Buffett is that his type of company has a "durable competitive advantage" as compared to being a "price competitive" or "commodity" type of business. Companies with a "durable competitive advantage" are more likely to be found in these sub-industries: Brand Name Fast Food Restaurants, Brand Name Beverages, Brand Name Foods, Brand Name Toiletries and Household Products, Brand Name Clothing, Brand Name Prescription Drugs, Advertising, Advertising Agencies, TV, Newspapers, Magazines, Direct Mail, Repetitive Services for Businesses, Low Cost Producers of Insurance, furniture, or Low Cost Retailers. While you should be easily able to explain where the company's pricing power comes from (i.e. a strong regional brand image, a business tollgate, its main products are #1 or # 2 in its field and has been on the market for years and hasn't changed at all, a consumer or business ends up buying the same product many times in a year, etc. or having the lowest production cost among its competition), there are certain figures that one can look at that can qualify the company as having a durable competitive advantage.


LOOK FOR EARNINGS PREDICTABILITY: PASS

Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings. Annual earnings per share from earliest to most recent were 1.36, 1.55, 1.75, 1.53, 2.14, 3.20, 4.40, 5.40, 6.65, 6.75. Buffett would consider PII's earnings predictable, although earnings have declined 1 time(s) in the past seven years, with the most recent decline 7 years ago. The dips have totaled 12.6%. PII's long term historical EPS growth rate is 15.7%, based on the 10 year average EPS growth rate, and it is expected to grow earnings 13.0% per year in the future, based on the analysts' consensus estimated long term growth rate. For the purposes of our analysis, we will use the more conservative of the two EPS growth numbers.


LOOK AT THE ABILITY TO PAY OFF DEBT PASS

Buffett likes companies that are conservatively financed. Nonetheless, he has invested in companies with large financing divisions and in firms with rather high levels of debt. PII has a debt of 463.3 million and earnings of 375.1 million, which could be used to pay off the debt in less than two years, which is considered exceptional.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON EQUITY: PASS

Buffett likes companies with above average return on equity of at least 15% or better, as this is an indicator that the company has a durable competitive advantage. US corporations have, on average, returned about 12% on equity over the last 30 years. The average ROE for PII, over the last ten years, is 44.1%, which is high enough to pass. It is not enough that the average be at least 15%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROE must be at least 10% for Buffett to feel comfortable that the ROE is consistent. In addition, the average ROE over the last 3 years must also exceed 15%. The ROE for the last 10 years, from earliest to latest, is 57.7%, 61.3%, 82.9%, 48.8%, 39.5%, 43.8%, 43.7%, 66.2%, 51.2%, 44.9%, and the average ROE over the last 3 years is 54.1%, thus passing this criterion.


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

Because some companies can be financed with debt that is many times their equity, they can show a consistently high ROE, yet still be in unattractive price competitive businesses. To screen this out, for non-financial companies Buffett also requires that the average Return On Total Capital (ROTC) be at least 12% and consistent. In addition, the average ROTC over the last 3 years must also exceed 12%. Return On Total Capital is defined as the net earnings of the business divided by the total capital in the business, both equity and debt. The average ROTC for PII, over the last ten years, is 33.0% and the average ROTC over the past 3 years is 38.2%, which is high enough to pass. It is not enough that the average be at least 12%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROTC must be at least 9% for Buffett to feel comfortable that the ROTC is consistent. The ROTC for the last 10 years, from earliest to latest, is 23.1%, 28.4%, 33.7%, 24.7%, 31.1%, 36.3%, 38.0%, 43.2%, 40.7%, 30.7%, thus passing this criterion.


LOOK AT CAPITAL EXPENDITURES: PASS

Buffett likes companies that do not have major capital expenditures. That is, he looks for companies that do not need to spend a ton of money on major upgrades of plant and equipment or on research and development to stay competitive. PII's free cash flow per share of $0.76 is positive, indicating that the company is generating more cash that it is consuming. This is a favorable sign, and so the company passes this criterion.


LOOK AT MANAGEMENT'S USE OF RETAINED EARNINGS: PASS

Buffett likes to see if management has spent retained earnings in a way that benefits shareholders. To figure this out, Buffett takes the total amount of retained earnings over the previous ten years of $23.25 and compares it to the gain in EPS over the same period of $5.39. PII's management has proven it can earn shareholders a 23.2% return on the earnings they kept. This return is more than acceptable to Buffett. Essentially, management is doing a great job putting the retained earnings to work.


HAS THE COMPANY BEEN BUYING BACK SHARES: BONUS PASS

Buffett likes to see falling shares outstanding, which indicates that the company has been repurchasing shares. This indicates that management has been using excess capital to increase shareholder value. PII's shares outstanding have fallen over the past five years from 68,430,000 to 65,000,000, thus passing this criterion. This is a bonus criterion and will not adversely affect the ability of a stock to pass the strategy as a whole if it is failed.

The preceding concludes Buffett's qualitative analysis. If and when he gets positive responses to all the above criteria, he would then proceed with a price analysis. The price analysis will determine whether or not the stock should be bought. The following is how he would evaluate PII quantitatively.

STAGE 2: "Should I buy at this price?" Although a firm may be a Buffett type company, he won't invest in it unless he can get a favorable price that allows him a great long term return.


CALCULATE THE INITIAL RATE OF RETURN: [No Pass/Fail]

Buffett compares his type of stocks to bonds, and likes to see what a company's initial rate of return is. To calculate the initial rate of return, take the trailing 12-month EPS of $5.77 and divide it by the current market price of $91.22. An investor, purchasing PII, could expect to receive a 6.33% initial rate of return. Furthermore, he or she could expect the rate to increase 13.0% per year, based on the analysts' consensus estimated long term growth rate, as this is how fast earnings are growing.


COMPARE THE INITIAL RATE OF RETURN WITH THE LONG-TERM TREASURY YIELD: PASS

Buffett favors companies in which the initial rate of return is around the long-term treasury yield. Nonetheless, he has invested in companies with low initial rates of return, as long as the yield is expected to expand rapidly. Currently, the long-term treasury yield is about 2.25%. Compare this with PII's initial yield of 6.33%, which will expand at an annual rate of 13.0%, based on the analysts' consensus estimated long term growth rate. The company is the better choice, as the initial rate of return is close to or above the long term bond yield and is expanding.


CALCULATE THE FUTURE EPS: [No Pass/Fail]

PII currently has a book value of $14.41. It is safe to say that if PII can preserve its average rate of return on equity of 44.1% and continues to retain 66.25% of its earnings, it will be able to sustain an earnings growth rate of 29.2% and it will have a book value of $187.42 in ten years. If it can still earn 44.1% on equity in ten years, then expected EPS will be $82.73.


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

Now take the expected future EPS of $82.73 and multiply them by the lower of the 5 year average P/E ratio (19.8) or current P/E ratio (current P/E in this case), which is 15.8 and you get PII's projected future stock price of $1,308.80.


CALCULATE THE EXPECTED RATE OF RETURN BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now add in the total expected dividend pool to be paid over the next ten years, which is $40.53. This gives you a total dollar amount of $1,349.33. These numbers indicate that one could expect to make a 30.9% average annual return on PII's stock at the present time. Buffett would consider this an absolutely fantastic expected return.


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

If you take the EPS growth of 13.0%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $19.59. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio (19.8) or current P/E ratio (current P/E in this case), which is 15.8. This equals the future stock price of $309.86. Add in the total expected dividend pool of $40.53 to get a total dollar amount of $350.39.


CALCULATE THE EXPECTED RETURN USING THE AVERAGE EPS GROWTH METHOD: [No Pass/Fail]

Now you can figure out your expected return based on a current price of $91.22 and the future expected stock price, including the dividend pool, of $350.39. If you were to invest in PII at this time, you could expect a 14.41% average annual return on your money. Buffett likes to see a 15% return, but nonetheless would accept this return.


LOOK AT THE RANGE OF EXPECTED RATE OF RETURN: PASS

Based on the two different methods, you could expect an annual compounding rate of return somewhere between 14.4% and 30.9%. To pinpoint the average return a little better, we have taken an average of the two different methods. Investors could expect an average return of 22.7% on PII stock for the next ten years, based on the current fundamentals. Buffett would consider this an exceptional return, thus passing the criterion.

SUPREME INDUSTRIES, INC.

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

Supreme Industries, Inc. (Supreme) is a manufacturer of specialized vehicles, including truck bodies, trolleys and specialty vehicles. The Company operates through two segments, which include specialized commercial vehicles and fiberglass products. The Company manufactures specialized commercial vehicles that are attached to a truck chassis. The Company's truck bodies are offered in aluminum, FiberPanel PW, FiberPanel HC, or SignaturePlate. The Company's products include Signature van bodies, Iner-City cutaway van bodies, Spartan service bodies, Spartan cargo vans, Kold King insulated van bodies, stake bodies, armored sport utility vehicles (SUVs), armored trucks and specialty vehicles, and trolleys. Its products are attached to light-duty truck chassis and medium-duty truck chassis. Supreme integrates a range of options into its truck bodies, including liftgates, cargo-handling equipment, customized doors, special bumpers, ladder racks and refrigeration equipment.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (15.11) relative to the growth rate (30.86%), based on the average of the 3 and 4 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for STS (0.49) is very favorable.


SALES AND P/E RATIO: NEUTRAL

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth rate high enough to support a P/E above this threshold. STS, whose sales are $294.9 million, is not considered large enough to apply the P/E ratio analysis. However, an investor can analyze the P/E ratio relative to the EPS growth rate.


INVENTORY TO SALES: PASS

When inventories increase faster than sales, it is a red flag. However an increase of up to 5% is considered bearable if all other ratios appear attractive. Inventory to sales for STS was 9.59% last year, while for this year it is 8.98%. Since inventory to sales has decreased from last year by -0.61%, STS passes this test.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for STS is 30.9%, based on the average of the 3 and 4 year historical eps growth rates, which is acceptable.


TOTAL DEBT/EQUITY RATIO: PASS

This methodology would consider the Debt/Equity ratio for STS (8.01%) to be exceptionally low (equity is at least ten times debt). This ratio is one quick way to determine the financial strength of the company.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for STS (1.46%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for STS (4.59%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.

TREX COMPANY, INC.

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

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


PROFIT MARGIN: PASS

This methodology seeks companies with a minimum trailing 12 month after tax profit margin of 7%. The companies that pass this criterion have strong positions within their respective industries and offer greater shareholder returns. A true test of the quality of a company is that they can sustain this margin. TREX's profit margin of 12.68% passes this test.


RELATIVE STRENGTH: PASS

The investor must look at the relative strength of the company in question. Companies whose relative strength is 90 or above (that is, the company outperforms 90% or more of the market for the past year), are considered attractive. Companies whose price has been rising much quicker than the market tend to keep rising. TREX, with a relative strength of 91, satisfies this test.


COMPARE SALES AND EPS GROWTH TO THE SAME PERIOD LAST YEAR: FAIL

Companies must demonstrate both revenue and net income growth of at least 25% as compared to the prior year. These growth rates give you the dynamic companies that you are looking for. These rates for TREX (36.21% for EPS, and 7.07% for Sales) are not good enough to pass.


INSIDER HOLDINGS: FAIL

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


CASH FLOW FROM OPERATIONS: PASS

A positive cash flow is typically used for internal expansion, acquisitions, dividend payments, etc. A company that generates rather than consumes cash is in much better shape to fund such activities on their own, rather than needing to borrow funds to do so. TREX's free cash flow of $1.24 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

TREX's profit margin has been consistent or even increasing over the past three years (Current year: 10.91%, Last year: 10.60%, Two years ago: 10.10%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise.


R&D AS A PERCENTAGE OF SALES: NEUTRAL

This criterion is not critically important for companies that are not high-tech or medical stocks because they are not as R&D dependant as companies within those sectors. Not much emphasis should be placed on this test in TREX's case.


CASH AND CASH EQUIVALENTS: FAIL

TREX does not have a sufficiently large amount of cash, $6.00 million, on hand relative to its size. Although this criteria does not apply to companies of this size, we defined anything greater than $500 million in cash as having 'a lot of cash' to allow analysis of these companies. TREX will have more of a difficult time paying off debt (if it has any) or acquiring other companies than a company that passes this criterion.


INVENTORY TO SALES: PASS

This methodology strongly believes that companies, especially small ones, should have tight control over inventory. It's a warning sign if a company's inventory relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Inventory to Sales for TREX was 6.06% last year, while for this year it is 5.24%. Since the inventory to sales is decreasing by -0.82% the stock passes this criterion.


ACCOUNT RECEIVABLE TO SALES: PASS

This methodology wants to make sure that a company's accounts receivable do not get significantly out of line with sales. It's a warning sign if a company's accounts receivable relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Accounts Receivable to Sales for TREX was 9.29% last year, while for this year it is 11.91%. Although the AR to sales is rising, it is below the max 30% that is allowed. The investor can still consider the stock if all other criteria appear very attractive.


LONG TERM DEBT/EQUITY RATIO: PASS

TREX's trailing twelve-month Debt/Equity ratio (0.00%) is at a great level according to this methodology because the superior companies that you are looking for don't need to borrow money in order to grow.


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

The "Fool Ratio" is an extremely important aspect of this analysis. If the company has attractive fundamentals and its Fool Ratio is 0.5 or less (TREX's is 0.39), the shares are looked upon favorably. These high quality companies can often wind up as the biggest winners. TREX passes this test.

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

AVERAGE SHARES OUTSTANDING: PASS

TREX has not been significantly increasing the number of shares outstanding within recent years which is a good sign. TREX currently has 29.0 million shares outstanding. This means the company is not taking any measures, with regards to the number of shares, that will dilute or devalue the stock.


SALES: PASS

Companies with sales less than $500 million should be chosen. It is among these small-cap stocks that investors can find "an uncut gem", ones that institutions won't be able to buy yet. TREX's sales of $461.4 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". TREX passes the sales test.


DAILY DOLLAR VOLUME: PASS

TREX passes the Daily Dollar Volume (DDV of $17.0 million) test. It is required that this number be less than $25 million because these are the stocks that remain relatively undiscovered by institutions. "You'll be scoring touchdowns against the big guys on your turf."


PRICE: PASS

This is a very insignificant criterion for this methodology. But basically, low prices are chosen because "small numbers multiply more rapidly than large ones" and the potential for big returns expands. TREX with a price of $62.07 passes the price test, even though it doesn't fall in the preferred range. The price should be above $7 in order to eliminate penny stocks and below $20 since most stocks in this price range are undiscovered by the institutions.


INCOME TAX PERCENTAGE: PASS

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

JOHN B. SANFILIPPO & SON, INC.

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

John B. Sanfilippo & Son, Inc. is a processor and distributor of peanuts, pecans, cashews, walnuts, almonds and other nuts. The Company offers nuts under a range of private brands and under the Fisher, Orchard Valley Harvest, Fisher Nut Exactly and Sunshine Country brand names. The Company also markets and distributes a diverse product line of food and snack products, including snack mixes, salad toppings, snacks, snack bites, trail mixes, dried fruit, and chocolate and yogurt coated products under private brands and brand names. The Company's principal products are raw and processed nuts. The Company's nut product line includes black walnuts, English walnuts, macadamia nuts, pistachios, pine nuts, Brazil nuts and filberts. The Company's products are sold through various distribution channels to buyers of nuts, including food retailers, commercial ingredient users, contract packaging customers and international customers.


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical (non-Smokestack) companies with Price/Sales ratios below 0.75 are tremendous values and should be sought. JBSS's P/S of 0.61 based on trailing 12 month sales, is below 0.75 which is considered quite attractive. It passes this methodology's P/S ratio test with flying colors.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. JBSS's Debt/Equity of 17.99% is acceptable, thus passing the test.


PRICE/RESEARCH RATIO: PASS

This methodology considers companies in the Technology and Medical sectors to be attractive if they have low Price/Research ratios. JBSS is neither a Technology nor Medical company. Therefore the Price/Research ratio is not available and, hence, not much emphasis should be placed on this particular variable.


PRELIMINARY GRADE: Some Interest in JBSS At this Point

Is JBSS a "Super Stock"? NO


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical(non-Smokestack) companies with Price/Sales ratios below .75 are tremendous values and should be sought.JBSS's P/S ratio of 0.61 is below .75 which is considered extremely attractive. It passes this methodology's P/S ratio test with flying colors.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. JBSS's inflation adjusted EPS growth rate of 34.30% passes the test.


FREE CASH PER SHARE: PASS

This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. JBSS's free cash per share of 4.57 passes this criterion.


THREE YEAR AVERAGE NET PROFIT MARGIN: FAIL

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. JBSS, whose three year net profit margin averages 3.21%, fails this evaluation.


Watch List

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

Ticker Company Name Current
Score
WAL WESTERN ALLIANCE BANCORPORATION 50%
SSL SASOL LIMITED (ADR) 48%
THO THOR INDUSTRIES, INC. 46%
AMWD AMERICAN WOODMARK CORPORATION 45%
ANIK ANIKA THERAPEUTICS INC 45%
HOMB HOME BANCSHARES INC 45%
UFPI UNIVERSAL FOREST PRODUCTS, INC. 44%
WGO WINNEBAGO INDUSTRIES, INC. 44%
SIMO SILICON MOTION TECHNOLOGY CORP. (ADR) 43%
RHI ROBERT HALF INTERNATIONAL INC. 42%



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