Economy & Markets

Economists have steadily revised up their estimates for GDP growth this year, to 3%, despite the possibility that trade conflict, rising interest rates and the fading effects of tax breaks could derail that trajectory. These triple worries have seeped into the market, where the S&P 500 has barely budged in the last few days, though the index is just shy of its January peak and volatility has fallen. But if the dog days of summer have arrived on Wall Street, the much anticipated rotation out of growth stocks has not happened. The growth index is up nearly 3% while the value stock index isn't even up 1%, despite some earlier signs that technology was losing its leading edge. The S&P is trading at a multiple near 25. Technology and consumer discretionary stocks have led the index over the last year, while telecommunication and consumer staples are the laggards.

Some positive numbers:

1. The Labor Department says there were 6.6 million open jobs as of June, more than the 6.56 million people looking for work even though businesses are stepping up their hiring.

2. Some big Wall Street banks are forecasting economic growth of 3% for the year but they say the rise might only be temporary. Economists still say longer-run GDP growth will be closer to 2%.

3. The producer price index was unchanged in July but economists had expected a rise of 0.2%.

Some not-so-positive numbers:

1. American workers' paychecks have gotten bigger but their purchasing power is the same as it was 40 years ago, Pew Research said.

2. Western states are seeing the sharpest decline, 4.1%, for existing home sales in the second quarter. The drop off is attributed to rising home prices, rising mortgage rates and a drop off in buyers from China.

Recommended Reading

Mohnish Pabrai, a value investor whose Pabrai Investment Funds has $800 million under management, told Sumzero in a recent interview that he has no U.S. investments at the moment. That is something that hasn't happened in 19 years, he adds, but he says it's because he can't find anything worth buying. "I find the USA a very difficult area to find mispriced securities." For more on Pabrai's views on the current market, click here . And see below for more articles and blog posts you might have missed.

Chaos Coming Bloomberg recently interviewed a bunch of hedge fund managers who see market chaos on the horizon. Read more

Getting Better Morningstar found investors may be resisting the urge to act against their best interests. The average fund gained 5.79% annually over the 10 years ended March 31st while the average investor gained 5.53%, a much narrower difference than in the past. Read more

Active Wins Quinnipiac's endowment returns of 6.1% annually for the last decade ranked them in the top decile and that's because the managers have done old fashioned stock picking rather than rely on index funds and private equity. Read more

ESG Works Contrary to popular opinion, factoring in environmental, social and governance issues in stock selection can lead to outperformance over time, according to a recent article in Barron's. Read more

Index Effect GE got removed from the Dow Jones Industrial Average and bounced. This has led some to conclude that the trend of removing underperforming components of the blue chip index is mistimed, the WSJ says. Dow exiles usually outperform it in the 12 months after they are removed. Read more

Volatility Trap Quant funds, including Renaissance Technologies, got caught flat footed in the volatility that returned to the market earlier this year. Read more

Small Victory While U.S. retail sales and consumer spending have continued to rise, weaker economic data from Europe and China have dampened hopes for synchronized global growth, the WSJ says. That makes small-cap stocks, which are more exposed to the U.S. market, attractive. Read more

Peak Market The best may already have happened. January's S&P 500 peak will probably prove to be the top of the current market, according to David Rosenberg, chief economist and strategist at Gluskin Sheff. Read more

Sell Off Hedge funds pitch their ideas at an investor conference and then sell those stocks to profit and wait for better investment opportunities, Bloomberg recently reported. Read more

Robo Pull Artificial intelligence will ultimately help robo advisors offer conflict free advice better than human advisors, according to a recent WSJ report. Read more

News on Hot List Stocks

Credit Acceptance Corp. reported adjusted second quarter earnings of $6.95 beating the consensus and a 33 percent gain over last year.

Schnitzer Steel Industries declared a dividend of 18.75 cents a share payable on August 27 to shareholders of record on August 13.

Alliance Data Systems approved a new $500 million stock buyback to begin August 1.

Magna International reported adjusted earnings per share of $1.67, falling short of expectations. However, earnings came in higher than the year-ago figure of $1.45.

Arista Networks settled its long-pending patent litigation with rival Cisco Systems, agreeing to pay $400 million.

Hot List Performance Update

Since our last newsletter, the S&P 500 returned 0.6%, while the Hot List returned -1.2%. So far in 2015, the portfolio has returned -7.6% vs. 6.7% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 236.0% vs. the S&P's 185.2% gain.

The Ups and the Downs of Avoiding Value Traps

The problem with value investing, other than that it can go through long periods of underperformance as the strategy has suffered under lately, is that some stocks are cheap for a reason. It's not that they are hidden or overlooked gems just waiting to be discovered. It's that there is something fundamentally flawed. The trick, of course, is figuring out whether you have a bargain or a dud.

At its most basic level, value investing is the process of finding financially solid companies with strong future growth prospects whose shares are languishing compared to peers. This does present some hazards.

A value trap is a cheap stock of a company that has lost its competitive edge. The business is no longer sustainable, so what appears at first blush to be a cheap stock is actually an expensive one. An investor isn't likely to get much of a return for their money.

There are some obvious ways to avoid value traps. If you can't understand the company's business model, despite what it says in its public disclosures, it might be best to avoid that stock. If management isn't buying the stock, or worse, appears to be selling more than it is buying, that can also be a warning sign.

But apart from these signals, the process of avoiding a value trap is complicated and can lead investors astray. In trying to weed them out, an investor can also inadvertently dismiss stocks that would be good investments on a relative basis. And accepting some duds in a portfolio in order to avoid that mistake can lead to disappointment.

At Validea we have worked out a few ways of testing for value traps in advance by focusing on those instances where the numbers don't match up with the true state of a business. We think this approach allows investors to identify value traps more often than not.

Over time we have come to realize that it isn't always better to just screen for the best stocks. A more successful approach is to exclude the worst stocks. So, instead of screening for value and quality, just screen for value. Testing over time, as research by Tobias Carlisle found, showed that screening only for value lead to higher returns. In our work, adding a positive quality screen on top of a value model resulted in a portfolio that included some expensive stocks, reducing long-term performance. But we did find some quality-based screens that were effective in weeding out the worst stocks:

1. Projected future earnings and sales

There can be a lag effect with the data. For example, oil stocks look good when oil prices fall rapidly but that's because the effect on future earnings isn't reflected in the data, which by its nature is backward looking. Looking for any major differences between past and future sales and profit can help avoid this trap.

2. Discrepancies between cash flow and profit

If cash flow consistently lags profit, that is a sign that profit is inflated. Eliminating the stocks of companies with the biggest difference between cash flow and profit can limit these value traps.

3. High debt levels

The typical value stock is a company that has some issues at the moment, and debt can be one of them. A company with a lot of debt doesn't have a lot of wiggle room and usually are higher risks in terms of credit worthiness. Screening out stocks of companies with high levels of debt reduces the risk of a value trap.

4. Low relative strength and high short interest

Obviously part of the trick is to weed out the stocks that perform the worst against peers on a relative basis, recognizing that it's not always possible to identify the fundamentals that are really causing a stock to lag behind. This is often where it is a good idea to take a cue from the pros. A heavily shorted stock usually indicates that professional traders have identified a stock that will be a poor performer. If it's not obvious from the sales and profit numbers, it often is evident in a volatile CEO. Tesla has found itself at the center of this debate. The most heavily shorted U.S. stock, in dollar terms, represents a company with issues hitting production targets and generating profits. The fact that its CEO is on Twitter making noises about taking the company private, in part because of negative bets against it, only adds fuel to the fire for short-sellers.

It's not going to be possible to avoid all the value traps you encounter in investing and even if you try to do so with 100% accuracy, you're going to be giving up something in the process. Just like trying to time the market, it can cause doubt and indecision to creep into your investment process. That's why at Validea we have developed systems and processes that take a lot of the guesswork out of investing. Common sense criteria can be helpful in limiting exposure to value traps while avoiding the unintended consequence of missing out on some hidden gems.


Portfolio Holdings
Ticker Date Added Return
CACC 3/9/2018 30.3%
SAFM 4/6/2018 -10.1%
AGX 7/27/2018 2.2%
TNET 6/29/2018 0.5%
SCHN 6/29/2018 -8.5%
ADS 7/27/2018 1.4%
MGA 6/29/2018 -7.3%
SBCF 5/4/2018 8.7%
NRZ 5/4/2018 0.8%
ANET 7/27/2018 -0.7%


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

CACC   |   SAFM   |   AGX   |   TNET   |   SCHN   |   ADS   |   MGA   |   SBCF   |   NRZ   |   ANET   |  

CREDIT ACCEPTANCE CORP.

Strategy: Growth Investor
Based on: Martin Zweig

Credit Acceptance Corporation offers financing programs that enable automobile dealers to sell vehicles to consumers. The Company's financing programs are offered through a network of automobile dealers. The Company has two Dealers financing programs: the Portfolio Program and the Purchase Program. Under the Portfolio Program, the Company advances money to dealers (Dealer Loan) in exchange for the right to service the underlying consumer loans. Under the Purchase Program, the Company buys the consumer loans from the dealers (Purchased Loan) and keeps the amounts collected from the consumer. Dealer Loans and Purchased Loans are collectively referred to as Loans. As of December 31, 2016, the Company's target market included approximately 60,000 independent and franchised automobile dealers in the United States. The Company has market area managers located throughout the United States that market its programs to dealers, enroll new dealers and support active dealers.


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. CACC's P/E is 13.31, based on trailing 12 month earnings, while the current market PE is 26.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: FAIL

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. CACC's revenue growth is 13.62%, while it's earnings growth rate is 30.32%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, CACC fails 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 (14.3%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (12.5%) of the current year. Sales growth for the prior must be greater than the latter. For CACC 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. CACC's EPS ($7.76) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. CACC's EPS for this quarter last year ($5.09) 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. CACC's growth rate of 52.46% 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 CACC is 15.16%. This should be less than the growth rates for the 3 previous quarters, which are 23.28%, 228.60%, and 30.72%. CACC 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, 92.67%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 52.46%, (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 CACC is 52.5%, and it would therefore pass this test.


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

The EPS growth rate for the current quarter, 52.46% must be greater than or equal to the historical growth which is 30.32%. CACC 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. CACC, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 10.54, 11.92, 14.28, 16.31 and 29.14, 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. CACC's long-term growth rate of 30.32%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes 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 CACC, this criterion has not been met (insider sell transactions are 818, while insiders buying number 71). 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.

SANDERSON FARMS, INC.

Strategy: Value Investor
Based on: Benjamin Graham

Sanderson Farms, Inc. is a poultry processing company. The Company is engaged in the production, processing, marketing and distribution of fresh and frozen chicken, and also preparation, processing, marketing and distribution of processed and minimally prepared chicken. It sells ice pack, chill pack, bulk pack and frozen chicken, in whole, cut-up and boneless form, under the Sanderson Farms brand name to retailers, distributors, casual dining operators, customers reselling frozen chicken into export markets. The Company, through its subsidiaries, Sanderson Farms, Inc. (Production Division) and Sanderson Farms, Inc. (Processing Division), conducts its chicken operations. Sanderson Farms, Inc. (Production Division) is engaged in the production of chickens to the broiler-stage. Sanderson Farms, Inc. (Foods Division) is engaged in the processing, sale and distribution of chickens. The Company, through Sanderson Farms, Inc. (Foods Division), conducts its prepared chicken business.


SECTOR: PASS

SAFM 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 $1 billion. SAFM's sales of $3,437.3 million, based on trailing 12 month sales, pass this test.


CURRENT RATIO: PASS

The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. SAFM's current ratio of 4.64 passes 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 SAFM is $0.0 million, while the net current assets are $631.7 million. SAFM 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 10 years. EPS for SAFM were negative within the last 10 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. SAFM's P/E of 10.10 (using the 3 year 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. SAFM's Price/Book ratio is 1.54, while the P/E is 10.10. SAFM passes the Price/Book test.

ARGAN, INC.

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

Argan, Inc. is a holding company. The Company conducts operations through its subsidiaries, Gemma Power Systems, LLC and affiliates (GPS), Atlantic Projects Company Limited (APC), Southern Maryland Cable, Inc. (SMC) and The Roberts Company (Roberts). Through GPS and APC, the Company's power industry services segment provides engineering, procurement, construction, commissioning, operations management, maintenance, development, technical and consulting services to the power generation and renewable energy markets. Through SMC, the telecommunications infrastructure services segment of the Company provides project management, construction, installation and maintenance services to commercial, local government and federal government customers. Through Roberts, the Company's industrial fabrication and field services segment produces, delivers and installs fabricated steel components specializing in pressure vessels and heat exchangers for industrial plants.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (11.04) relative to the growth rate (21.62%), 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 AGX (0.51) makes it 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. AGX, whose sales are $803.7 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 AGX was 0.60% last year, while for this year it is 0.36%. Since inventory to sales has decreased from last year by -0.25%, AGX 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 AGX is 21.6%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is considered very good.


TOTAL DEBT/EQUITY RATIO: PASS

This methodology would consider the Debt/Equity ratio for AGX (0.00%) to be wonderfully 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 AGX (-15.21%) 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: BONUS PASS

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 AGX (69.91%) is considered very favorable.

TRINET GROUP INC

Strategy: Growth Investor
Based on: Martin Zweig

TriNet Group, Inc. is a provider of human resources (HR) solutions for small to medium-sized businesses (SMBs). The Company's HR solutions include services, such as multi-state payroll processing and tax administration, employee benefits programs, including health insurance and retirement plans, workers' compensation insurance and claims management, employment and benefit law compliance, and other services. The Company provides an HR technology platform with online and mobile tools that allow its clients and their worksite employees (WSEs) to store, view and manage their HR-related information and conduct a range of HR-related transactions anytime and anywhere. The Company's HR products and solutions include capabilities, such as technology platform, HR expertise, benefits and compliance. The Company's clients are distributed across a range of industries, including technology, life sciences, financial services, property management, retail, manufacturing and hospitality.


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. TNET's P/E is 18.33, based on trailing 12 month earnings, while the current market PE is 26.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: FAIL

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. TNET's revenue growth is 19.75%, while it's earnings growth rate is 119.97%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, TNET fails 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 (6.2%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (6.6%) of the current year. Sales growth for the prior must be greater than the latter. For TNET 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. TNET's EPS ($0.80) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. TNET's EPS for this quarter last year ($0.56) 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. TNET's growth rate of 42.86% 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 TNET is 59.99%. This should be less than the growth rates for the 3 previous quarters, which are 200.00%, 187.50%, and 87.50%. TNET 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, 146.74%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 42.86%, (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 TNET is 42.9%, 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, 42.86% must be greater than or equal to the historical growth which is 119.97%. Since this is not the case TNET 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. TNET, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.06, 0.22, 0.44, 0.85 and 2.49, 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. TNET's long-term growth rate of 119.97%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes this test.


TOTAL DEBT/EQUITY RATIO: PASS

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. TNET's Debt/Equity (136.89%) is not considered high relative to its industry (330.28%) and passes 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 TNET, this criterion has not been met (insider sell transactions are 269, while insiders buying number 149). 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.

SCHNITZER STEEL INDUSTRIES, INC.

Strategy: Value Investor
Based on: Benjamin Graham

Schnitzer Steel Industries, Inc. is a recycler of ferrous and nonferrous scrap metal, including end-of-life vehicles, and a manufacturer of finished steel products. The Company operates through two segments: the Auto and Metals Recycling (AMR) business and the Steel Manufacturing Business (SMB). The AMR segment collects and recycles auto bodies, rail cars, home appliances, industrial machinery, manufacturing scrap and construction and demolition scrap from bridges, buildings and other infrastructure. AMR's primary products include recycled ferrous and nonferrous scrap metal. The SMB segment produces finished steel products such as rebar, wire rod, coiled rebar, merchant bar and other specialty products using 100% recycled metal sourced from AMR. SMB's products are primarily used in nonresidential and infrastructure construction in North America. SMB operates a steel mini-mill in McMinnville, Oregon that produces finished steel products using recycled metal and other raw materials.


SECTOR: PASS

SCHN 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 $1 billion. SCHN's sales of $2,189.4 million, based on trailing 12 month sales, pass this test.


CURRENT RATIO: PASS

The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. SCHN's current ratio of 2.20 passes 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 SCHN is $171.5 million, while the net current assets are $259.9 million. SCHN 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 10 years. EPS for SCHN were negative within the last 10 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. SCHN's P/E of 8.23 (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. SCHN's Price/Book ratio is 1.35, while the P/E is 8.23. SCHN passes the Price/Book test.

ALLIANCE DATA SYSTEMS CORPORATION

Strategy: Growth Investor
Based on: Martin Zweig

Alliance Data Systems Corporation is a provider of data-driven marketing and loyalty solutions serving consumer-based businesses in a range of industries. The Company offers a portfolio of integrated outsourced marketing solutions, including customer loyalty programs, database marketing services, end-to-end marketing services, analytics and creative services, direct marketing services, and private label and co-brand retail credit card programs. The Company operates through three segments: LoyaltyOne, which provides coalition and short-term loyalty programs through the Company's Canadian AIR MILES Reward Program and BrandLoyalty Group B.V. (BrandLoyalty); Epsilon, which provides end-to-end, integrated direct marketing solutions, and Card Services, which provides risk management solutions, account origination, funding, transaction processing, customer care, collections and marketing services for the Company's private label and co-brand retail credit card programs.


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. ADS's P/E is 15.60, based on trailing 12 month earnings, while the current market PE is 26.00. 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. ADS's revenue growth is 15.01%, while it's earnings growth rate is 15.77%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, ADS 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 (4.5%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (0.3%) of the current year. Sales growth for the prior must be greater than the latter. For ADS 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. ADS's EPS ($3.93) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. ADS's EPS for this quarter last year ($2.47) 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. ADS's growth rate of 59.11% 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 ADS is 7.88%. This should be less than the growth rates for the 3 previous quarters, which are 18.03%, 1,961.11%, and 13.95%. ADS 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, 71.79%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 59.11%, (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 ADS is 59.1%, and it would therefore pass this test.


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

The EPS growth rate for the current quarter, 59.11% must be greater than or equal to the historical growth which is 15.77%. ADS would therefore pass this test.


EARNINGS PERSISTENCE: FAIL

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. ADS, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 7.42, 7.87, 8.85, 7.34, and 12.95, fails 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. ADS's long-term growth rate of 15.77%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes 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 ADS, this criterion has not been met (insider sell transactions are 253, while insiders buying number 53). 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.

MAGNA INTERNATIONAL INC. (USA)

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

Magna International Inc. (Magna) is a global automotive supplier. The Company's segments are North America, Europe, Asia, Rest of World, and Corporate and Other. The Company's product capabilities include producing body, chassis, exterior, seating, powertrain, electronic, active driver assistance, vision, closure, and roof systems and modules, as well as vehicle engineering and contract manufacturing. The Company has over 320 manufacturing operations and approximately 100 product development, engineering and sales centers in over 30 countries. It provides a range of body, chassis and engineering solutions to its original equipment manufacturer (OEM) customers. It has capabilities in powertrain design, development, testing and manufacturing. It offers bumper fascia systems, exterior trim and modular systems. It offers exterior and interior mirror systems. It offers sealing, trim, engineered glass and module systems. It offers softtops, retractable hardtops, modular tops and hardtops.


DETERMINE THE CLASSIFICATION:

MGA is considered a "True Stalwart", according to this methodology, as its earnings growth of 12.66% lies within a moderate 10%-19% range and its annual sales of $40,962 million are greater than the multi billion dollar level. This methodology looks for the "Stalwart" securities to gain 30%-50% in value over a two year period if they can be purchased at an attractive price based on the P/E to Growth ratio. MGA is attractive if MGA can hold its own during a recession.


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 MGA was 7.69% last year, while for this year it is 9.09%. Since inventory has been rising, this methodology would not look favorably at the stock but would not completely eliminate it from consideration as the inventory increase (1.40%) is below 5%.


YIELD ADJUSTED P/E TO GROWTH (PEG) RATIO: PASS

The Yield-adjusted P/E/G ratio for MGA (0.55), based on the average of the 3, 4 and 5 year historical eps growth rates, is O.K.


EARNINGS PER SHARE: PASS

The EPS for a stalwart company must be positive. MGA's EPS ($6.43) would satisfy this criterion.


TOTAL DEBT/EQUITY RATIO: PASS

This methodology would consider the Debt/Equity ratio for MGA (39.08%) to be normal (equity is approximately twice debt).


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 MGA (5.31%) 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 MGA (-12.53%) 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.

SEACOAST BANKING CORPORATION OF FLORIDA

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

Seacoast Banking Corporation of Florida is a bank holding company. The Company's principal subsidiary is Seacoast National Bank, a national banking association (the Bank). The Company and its subsidiaries offer an array of deposit accounts and retail banking services, engage in consumer and commercial lending and provide a range of trust and asset management services, as well as securities and annuity products to its customers. The Company, through its bank subsidiary, provides a range of community banking services to commercial, small business and retail customers, offering a range of transaction and savings deposit products, treasury management services, brokerage, and secured and unsecured loan products, including revolving credit facilities, letters of credit and similar financial guarantees, and asset based financing. The Bank also provides trust and investment management services to retirement plans, corporations and individuals.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (19.60) relative to the growth rate (33.18%), 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 SBCF (0.59) makes it 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. SBCF, whose sales are $215.6 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 SBCF is 33.2%, based on the average of the 3 and 4 year historical eps growth rates, which is acceptable.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

SBCF 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. SBCF's Equity/Assets ratio (12.00%) 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. SBCF's ROA (1.27%) 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 SBCF (3.34%) 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 SBCF (2.32%) 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.

NEW RESIDENTIAL INVESTMENT CORP

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

New Residential Investment Corp. is a real estate investment trust (REIT). The Company focuses on investing in, and managing, investments related to residential real estate. The Company's segments include investments in excess mortgage servicing rights (Excess MSRs); investments in mortgage servicing rights (MSRs); investments in servicer advances; investments in real estate securities; investments in residential mortgage loans; investments in consumer loans, and corporate. Its portfolio includes mortgage servicing related assets, residential mortgage backed securities (RMBS), residential mortgage loans and other investments. The Company's servicing related assets include its investments in Excess MSRs, MSRs and servicer advances. The Company invests in agency RMBS and non-agency RMBS. The Company's other investments consist of consumer loans.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (4.57) relative to the growth rate (24.79%), 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 NRZ (0.18) 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. NRZ, whose sales are $2,440.2 million, needs to have a P/E below 40 to pass this criterion. NRZ's P/E of (4.57) 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 NRZ is 24.8%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is considered very good.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

NRZ 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. NRZ's Equity/Assets ratio (25.00%) 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. NRZ's ROA (5.79%) 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 NRZ (7.96%) 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 NRZ (-104.31%) 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.

ARISTA NETWORKS INC

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

Arista Networks, Inc. is a supplier of cloud networking solutions that use software innovations to address the needs of Internet companies, cloud service providers and data centers for enterprise support. It develops, markets and sells cloud networking solutions, which consist of its Gigabit Ethernet switches and related software. The Company's cloud networking solutions consist of its Extensible Operating System (EOS), a set of network applications and its Ethernet switching and routing platforms. The programmability of EOS has allowed it to create a set of software applications that address the requirements of cloud networking, including workflow automation, network visibility and analytics, and has also allowed it to integrate with a range of third-party applications for virtualization, management, automation, orchestration and network services. EOS supports cloud and virtualization solutions, including VMware NSX, Microsoft System Center and other cloud management frameworks.


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. ANET's profit margin of 14.68% passes this test.


RELATIVE STRENGTH: FAIL

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. Although ANET's relative strength of 87 is below the acceptable level, yet it is very close. Keep an eye on the stock as it could move into the acceptable range.


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 ANET (-223.81% for EPS, and 18.79% for Sales) are not good enough to pass.


INSIDER HOLDINGS: PASS

ANET's insiders should own at least 10% (they own 22.84% ) of the company's outstanding shares which is the minimum required. A high percentage typically indicates that the insiders are confident that the company will do well.


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. ANET's free cash flow of $7.80 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

ANET's profit margin has been consistent or even increasing over the past three years (Current year: 25.71%, Last year: 16.31%, Two years ago: 14.46%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise.


R&D AS A PERCENTAGE OF SALES: FAIL

ANET has reduced their R&D expenditures(currently $349.6 million) over the past two years which is unacceptable. ANET is jeopardizing the future in order to boost current EPS numbers. This criterion is particularly important for high-tech and medical stocks because they are so R&D dependant.


CASH AND CASH EQUIVALENTS: PASS

ANET's level of cash $1,535.6 million passes this criteria. If a company is a cash generator, like ANET, it has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash.


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 ANET was 26.28% last year, while for this year it is 20.67%. Since the inventory to sales is decreasing by -5.61% 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 ANET was 22.42% last year, while for this year it is 15.03%. Since the AR to sales is decreasing by -7.39% the stock passes this criterion.


LONG TERM DEBT/EQUITY RATIO: PASS

ANET's trailing twelve-month Debt/Equity ratio (2.13%) is a little higher than what this methodology is looking for, but is still at an acceptable level. The superior companies that you are looking for don't need to borrow money in order to grow. This company has borrowed very little which is still OK.


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

The "Fool Ratio" is an extremely important aspect of this analysis. The methodology says consider selling the shares when the company's Fool Ratio is between 1.0 and 1.30. (ANET's is 1.11). This is considered to be high.

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

AVERAGE SHARES OUTSTANDING: FAIL

ANET has either issued a significant amount of new shares over the past year or has been issuing more and more shares over the past five years. ANET currently has 74.0 million shares outstanding. Neither of these are a good sign. Generally when a small-cap company issues more stock, the existing stock becomes devalued by the market, and hence diluted.


SALES: FAIL

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. ANET's sales of $1,897.8 million based on trailing 12 month sales, are too high and would therefore fail the test. It is companies with $500 million or less in sales that are most likely to double or triple in size in the next few years.


DAILY DOLLAR VOLUME: FAIL

ANET does not pass the Daily Dollar Volume (DDV of $212.3 million) test. It exceeds the maximum requirement of $25 million. Stocks that fail the test are too liquid for a small individual investor and many institutions have already discovered it.


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. ANET with a price of $269.34 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: FAIL

ANET's income tax paid expressed as a percentage of pretax income either this year (-0.05%) or last year (23.96%) is below 20% which is cause for concern. Because the tax rate is below 20% this could mean that the earnings that were reported are unrealistically inflated due to the lower level of income tax paid. However, we have utilized a sophisticated formula so that the appropriate figures reflect a 'normal' tax rate (35%).


Watch List

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

Ticker Company Name Current
Score
UFPI UNIVERSAL FOREST PRODUCTS, INC. 73%
UVE UNIVERSAL INSURANCE HOLDINGS, INC. 67%
DHI D. R. HORTON INC 55%
THO THOR INDUSTRIES, INC. 52%
CPRT COPART, INC. 52%
BMA BANCO MACRO SA (ADR) 51%
APPF APPFOLIO INC 49%
UTHR UNITED THERAPEUTICS CORPORATION 48%
WDFC WD-40 COMPANY 44%
LMAT LEMAITRE VASCULAR INC 44%



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