The Economy

While global markets have been quite volatile in the first two weeks of 2016, the US economy continues to look pretty solid, particularly when compared to the rest of the world.

The economy added 292,000 jobs during December, for example, the Labor Department said. In addition, the October and November jobs-added figures were revised higher by a total of 50,000. The unemployment rate stayed at 5.0%, the lowest it has been since April 2008. The "U-6" rate, which unlike the headline number takes into account those working part-time who want full-time work, and discouraged workers who have given up looking for a job, stayed at 9.9%, the third straight month it has been below 10%, a mark it hadn't fallen below since the first half of 2008. The strong jobs market seems to be drawing back people who had given up looking for work, too. The number of people not in the labor force has declined in each of the last 3 months; in December alone, it fell nearly 300,000. That may be keeping a lid on wage growth: Average hourly wages were just about flat vs. November.

New data also showed that the divergence is continuing between the manufacturing and service sectors. The service sector remains a major bright spot. It expanded in December for the 71st straight month, according to the Institute for Supply Management. The rate of expansion was at about the same strong pace as it was in November. New order growth also remained at a high level, as did employment conditions.

The manufacturing sector, on the other hand, has been sluggish. It contracted for the second straight month in December, according to ISM. New order growth did accelerate slightly, but employment conditions worsened. The manufacturing weakness we have seen in recent months likely has a lot to do with the big decline in commodity prices. Oil, gas, and materials companies have all been suffering.

Speaking of commodities, oil and gas prices keep sliding. As of January 13, a gallon of regular unleaded on average cost $1.95, down from $2.02 a month earlier. We have now reached the point at which year-ago comparisons are a lot less dramatic, however. Rather than the 20%-plus year-to-year changes we have seen for much of the past year, the gap is now about 8%.

Overseas, China has been in the spotlight once again. Disappointing data released just after the New Year appeared to be behind a big selloff in Chinese markets that sparked smaller selloffs in the US and abroad. Some reports indicated that the Chinese declines were in fact more to do with new regulations regarding Chinese asset sales than with the manufacturing data, however. Either way, the focus on China has an air of overreaction, with US investors taking every economic report coming out of the country as a clear indication of what China's future holds. The reality is of course much more complex.

Since our last newsletter, the S&P 500 returned -6.0%, while the Hot List returned -3.2%. So far in 2016, the portfolio has returned -3.2% vs. -6.0% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 172.6% vs. the S&P's 92.1% gain.

The Year In Review

In our last rebalancing newsletter, I talked about how it was very unlikely that the Hot List would beat the S&P 500 for the full 2015 year, and I looked at some of the reasons why fundamental- and value-focused strategies like ours have stumbled over the last year or two. Well, the final results are in, and the portfolio did indeed fall well short of the S&P in 2015. It's not surprising, given that my strategies tend to key on smaller, value-type stocks. In 2015, US large-cap stocks were just about flat, posting average losses of 0.3%, according to Morningstar. US small-cap stocks, meanwhile, were down more than 6% for the year. US growth stocks gained 4.4% during the year; US value stocks, meanwhile, were down 5%. Combine the sizes and styles and the results are much worse: US small value stocks were down 11% in 2015, while large US growth stocks were up 6.4%. As I discussed last time, that gap is completely antithetical to the long-term historical averages; according to the data of noted financial researcher Kenneth French, from 1927 through 2014, small value stocks outperformed large growth stocks by an average of more than 5 percentage points annually.

This newsletter, I'd like to look a bit deeper into performance of both the Hot List and my other guru-inspired portfolios in 2015. Overall, the 14 ten-stock portfolios averaged a 12.8% loss for the year vs. the S&P 500's 0.7% loss. Only two of the fourteen beat the S&P. The good news is that while many of their leads on the broader market narrowed in 2015, 11 of the 14 are still beating the S&P since their inceptions, with six returning at least 3 percentage points more per year than the index (which has averaged a 5.2% annualized return since these portfolios' mid-2003 inceptions). Here's a look at a few notable strategies' 2015 performances. All since-inception performance data is as of Jan. 14.

The Hot List

The Hot List portfolio had a difficult year, as its value, small-cap, energy and international exposure all proved to be problematic. For the year, the portfolio lost 12.9% compared to the S&P 500's loss of 0.7%. Despite the last two years of relative underperformance, the portfolio still maintains a lead over the S&P 500 since its inception in 2003. Over the last 12+ years, it has generated a return of 168.2% compared to 88.9% for the S&P 500. That's an 8.2% annualized return compared to 5.2% for the index.

As you may know, the Hot List portfolio looks for stocks that get the best consensus scores from all of my guru-inspired models, with the models with the best risk-adjusted long-term performance being weighted more heavily. It did find some nice winners in 2015. For example, WisdomTree Investments gained 24.6% from September-November. Other notable winners included Heritage Insurance, up 16.9% from September-November, and Credit Acceptance, up 18.5% from March-June.

On the flip side, a number of larger losing positions, particularly after the mid-point of the year, hurt the Hot List's returns. Among them were Chart Industries (down 41.8% from March-November), Universal Insurance (down 23.3% from August-November), and Lumber Liquidators (down 30.1% from June-August).

The Warren Buffett-based Portfolio

The Buffett-based approach was our best-performing value strategy in 2015, losing 3.0% for the year, which was just a hair behind the S&P 500's 0.7% loss. Since the model's 2003 inception date, the 10-stock monthly rebalanced portfolio has returned 119.4% compared to the S&P 500's return of 78.1% and has delivered a 55% accuracy rating (meaning that 5.5 out of every 10 holdings in the portfolio have appreciated from the buy price). As of the end of 2015, the Buffett 10-stock portfolio was the fifth-best performing value-focused strategy we track. It carries a beta of 1.05 and tends to be less volatile than many of our other model portfolios.

The Buffett-based model is based on the book Buffettology, written by Buffett's former daughter-in-law Mary Buffett, who worked closely with "The Oracle of Omaha." It is one of our most rigorous approaches, digging a full decade back into a firm's history to make sure it has the track record worthy of a Buffett-type pick. Due to its selection criteria, the model tends to choose stocks of many well-known, larger companies. For example, in 2015 the model selected a number of widely followed issues, including Apple, Kellogg, TJX Companies and Monster Beverage. A few of the portfolio's top-performing positions during the year included Ross Stores (up 76.6% through year-end) and Monster Beverage (up 99% from May 2014 to July 2015). On the downside, Apple detracted from the model's returns and losing positions like Polaris Industries (down 35.1%), FMC Technologies (down 22.6%) and World Acceptance Corp. (down 29.6%) also hurt the full-year results.

The Motley Fool-based Portfolio

The Motley Fool portfolio did it again -- it outperformed the market by a wide margin for another year. After a somewhat disappointing 2014, the model got back to its winning ways in 2015 with a 9.0% gain, compared to a 0.7% loss for the S&P 500. Overall, the Fool-based portfolio has an impeccable record. In fact, it is our best-performing individual guru 10-stock portfolio over the long haul, averaging annual gains of 13.7% since its inception vs. 5.2% for the S&P. Since 2003, the portfolio has only underperformed the market in two years (2012 and 2014), and when it does outperform, the excess return over the market tends to be substantial.

The Fool strategy is based on the approach that Fool co-creators Tom and David Gardner laid out in the Motley Fool Investment Guide: How the Fools Beat Wall Street's Wise Men and How You Can Too. The Fool-based approach centers on finding the stocks of small, fast-growing companies that have solid fundamentals. Healthy profit margins, low debt, strong cash flows, and good research and development budgets are all important to the strategy, which also uses the P/E-to-Growth ratio to help avoid fast-growing but overpriced stocks. The combination of growth criteria and a momentum component helped the model avoid some of the problem areas of the market in 2015 (i.e. energy, non-US companies), while at the same time capitalize on opportunities.

A number of holdings that were added in 2014 and sold in 2015 added nicely to the portfolio return for the year. Two of those stocks were Vasco Data Security and Universal Insurance Holdings, with each up over 40% and held for less than 12 months. The portfolio held Abiomed, a medical device maker, for a month and banked a 26.8% return, and a position in Natural Health Trends proved to be a big winner, too, with that stock rising 59.4% between August and the end of October.

On the downside, positions in Noah Holdings, a non-US play, and Heritage Insurance were drags on performance, with those stocks declining 33.4% and 19.8%, respectively. The model also lost on WisdomTree Investments (down 36.7%) and Marcus & Millichap (down 25.7%). Strategies that outperform can still have big losing positions, as the data here shows.

The portfolio produced an accuracy of 45% for 2015, meaning 45% of its positions were winners, which is slightly below the model's long-term historical average of close to 51%. Still, in a year like 2015, when many models and active managers underperformed, it was impressive to see the Fool strategy demonstrate the ability to find winning stocks in a difficult stock-picking environment.

The Top 5 Gurus Portfolio

Like the Hot List portfolio, the Top 5 Gurus portfolio has a stellar long-term track record, but underperformed by a wide margin in 2015. For the full year, the portfolio was down 20.0%, compared to a 0.7% loss for the S&P 500. The underperformance in 2015 was the portfolio's worst since its mid-2003 inception. The only other year it struggled as much was 2006, when it trailed the market by 16%. However, the recent performance needs to be looked at in a long-term context. The Top 5 Gurus portfolio still maintains an outstanding long-term track record, one of the best - since mid-2003 the portfolio has returned 11.6% per annum, which is more than double the S&P 500's annual return of 5.2% per year over the same timeframe. That's an overall 294.2% gain vs. 88.9% for the index. This return puts the portfolio in the #2 position overall out of all of our portfolios since their 2003 inception date.

The portfolio (which uses the top two picks from five top-performing strategies) was only accurate on about 42% of its picks throughout the year. This is well below its long-term accuracy average of 56%. Despite its disappointing performance during the year, there were some individual standouts in the portfolio. For example, Amtrust Financial was up 18.1% from April-October, King Digital was up 23.7% from July-November, and WSFS Financial, added to the portfolio in September, gained 14.6% through year-end.

But the Top 5 Gurus portfolio also found a number of significant losers. BOFI Holdings was down 35.4% from August-November, HCI Group was down 17.9% from April-August, and Chesapeake Energy was down 22% from May-early July.

The Momentum Investor Portfolio

Our second-best performer in 2015 was the Momentum approach, which gained 2.4% (3.1% excess return over the market). The portfolio was accurate on just about half of its picks (49%) throughout the year, proving once again that you don't need to be right anywhere close to all the time to notch market-beating gains.

There are common characteristics between the Fool and the Momentum model. Both focus on growth-like stocks and both have a price momentum component in their selection criteria. In 2015, the market rewarded growth over value, and it's no surprise that this approach came in second in performance for the year. The Momentum model looks for firms with strong short- and long-term earnings growth and high relative strengths (i.e. price momentum), as well as high returns on equity and low or declining debt/equity ratios. The strategy found some nice winners in 2015. Among them: Credit Acceptance (up 27.9%), Eagle Bancorp (up 18.9%), and IPG Photonics (up 12.9%).

The Momentum portfolio also had some losers, like Universal Insurance, down 33.9% from September-November and BOFI Holdings, down 16.9% over a two-month period. One of the more interesting holdings during the year was Apple, which was added to the portfolio twice, once in the late Spring and once in the late Fall. Apple's stock had a difficult year, but at times the shares performed well, which is why the Momentum model added them, but in both instances the strategy was quick to sell as momentum receded. Overall, the position in the technology giant was a net drag on performance.

Since its mid-2003 inception, the Momentum Investor portfolio is up 155.3% vs. 88.9% for the S&P 500. That's an 7.8% annualized gain vs. 5.2% for the index, even though it has been accurate on less than half of its picks (46.3%). Its ability to find and ride big winners has helped it notch those nice long-term gains.

Lessons for 2016

While 2015 was a difficult year for stocks, 2016 so far has been downright abysmal. Through January 13, the S&P 500 was down 7.5% year-to-date. The NASDAQ Composite was down 9.6%, and the Russell 2000 index of smaller stocks was down 11.0%. That has put the S&P and NASDAQ in correction territory, and the Russell 2000 in bear market territory. What's more, the S&P losses would be much greater if not for a few of its largest members. The average stock index is actually down 24% from it's 52-week high.

All of this is convincing many that the six-plus-year-old bull market is finally over. I'll believe it when I see it. The truth is that no one knows for sure whether this is the start of a bear or a hiccup in the middle of a bull run.

Most importantly, times like these aren't times when you should be bailing on a strategy or the market. Instead, they are times when good investors lay the groundwork for big future rewards, buying up shares of good companies that have been unfairly punished in a gloomy market environment.

So, as we move into 2016, I think it will be more important to keep broader investing lessons in mind than it will be to obsess over every data point and market move. With that in mind, here are pieces of advice from four of the gurus I follow that I think will be particularly important to remember this year.

1. "The investor cannot enter the arena of the stock market with any real hope of success unless he is armed with mental weapons that distinguish him in kind --not in a fancied superior degree -- from the trading public. If the investor intends to buy and sell recurrently, his weapons must be a frame of mind and a principle of action which are basically different from those of the trader and speculator. He must deal in values, not in price movements. He must be relatively immune to optimism or pessimism and impervious to business or stock-market forecasts. In a word, he must be psychologically prepared to be a true investor and not a speculator masquerading as an investor."

-- Benjamin Graham, The Intelligent Investor


When you are more than six years into a bull market, the so-called easy gains are likely behind you. The wild, bargain-creating fears of 2008 and 2009 are long gone, and valuations are, on average, slightly on the high side. In such an environment, it's tempting to look for any sort of advantage you can get on your fellow investors, and all too often people think such "advantages" come in the form of a superior sense of timing. But the real advantage the average investor can get on his peers, as Graham understood, doesn't involve finding ways to be a better speculator. Instead, it involves steering clear of speculative practices altogether. That's a hard thing to do, but over the long term, you'll be better off if you take Graham's advice.

2. "Now no one seems to know when [bear markets] are going to happen. At least if they know about them, they're not telling anybody about them. I don't remember anybody predicting the market right more than once, and they predict a lot. When [a bear market is] going to start, no one knows. If you're not ready for that, you shouldn't be in the stock market. I mean stomach is the key organ here. It's not the brain. Do you have the stomach for these kind of declines?"

--Peter Lynch, 1996 interview with PBS's Frontline


Many investors might think that Lynch and other greats fared so well because they knew when to sidestep market downturns. That is far from the truth, however. Lynch's portfolio fell 22.6% in 1981 amid a tough bear market. Warren Buffett took a 43.7% hit during a bear market in 1974. John Neff lost 25% when that same bear market started in 1973. These and other gurus didn't succeed by presciently avoiding bear markets; they succeeded because they stood their ground during the tough times, which allowed them to pick up good stocks at bargain prices when others jumped out of the market.

3. "In the 54 years [Charlie Munger and I] have worked together, we have never forgone an attractive purchase because of the macro or political environment."

-- Warren Buffett, 2014 letter to Berkshire Hathaway shareholders


Will it be Hillary? Trump? Cruz? Will the Federal Reserve keep raising interest rates? When? By how much?

You can be sure that macro and political speculation will run rampant in 2016. And if you think you can predict not only how the presidential election, Fed policy, China's economic situation, and other events will play out, but also what sort of impact all of those issues will have on the stock market, you are heading for trouble. Don't get caught up in the headlines and type. Look for good companies whose shares are selling on the cheap, and buy them. Period.

4. "Computers. Astrology. Demographic studies. Sunspots. Economics. Technical analysis. Tea leaves. The skin of a dried lizard at sunset cast to the wind. Political analysis. Just about anything else you could think to name.

"None of it works well."

-- Kenneth Fisher, discussing the myriad of short-term market-timing techniques investors have tried throughout history in Super Stocks.


People always think that they have the key to successfully timing the market in the short term. Just look at all the pundits offering their oh-so-certain predictions for what will happen in 2016. If history is any guide, you can bet that many, if not most, will be wrong.

The danger with thinking you can predict short-term market movements is two-fold. First, there is the fact that, unless you are gifted with the preternatural ability to predict truly unpredictable short-term stops and starts, you will be wrong a good deal of the time. But just as importantly, you are bound to be right some the time because of sheer luck. And in those situations, mistaking luck for skill can lead to overconfidence in your ability to time the market. That can lead you to make bigger and bigger bets, which will make it even worse when your luck runs out. So put away the dried lizard skins, and buy cheap stocks of good companies.

A Prediction

I will offer one prediction for 2016: At some point during the year -- probably many times -- you will be tempted to cast aside talk of "discipline" and "the long-term" and bail on stocks. Maybe it will be because of headline-grabbing macro fears, or poor performance from your own portfolio, or something an intelligent-sounding strategist writes or says.

At those times, think back to successful investors like Graham, Lynch, Buffett, and Fisher. Remember what they said and what they did to succeed over the long haul. Heed their advice and follow their example, and your portfolio should be much better off over the long run, regardless of what might occur in the coming 12 months.

The Fallen

As we rebalance the Validea Hot List, 7 stocks leave our portfolio. These include: National-oilwell Varco, Inc. (NOV), Syntel, Inc. (SYNT), Thor Industries, Inc. (THO), Sanderson Farms, Inc. (SAFM), Polaris Industries Inc. (PII), Eplus Inc. (PLUS) and Tesoro Corporation (TSO).

The Keepers

3 stocks remain in the portfolio. They are: Valero Energy Corporation (VLO), Cal-maine Foods Inc (CALM) and Banco Macro Sa (Adr) (BMA).

The New Additions

We are adding 7 stocks to the portfolio. These include: Tjx Companies Inc (TJX), Dril-quip, Inc. (DRQ), Edwards Lifesciences Corp (EW), Amtrust Financial Services Inc (AFSI), Lumber Liquidators Holdings Inc (LL), Altisource Portfolio Solutions S.a. (ASPS) and Lendingtree Inc (TREE).

Latest Changes

Additions  
TJX COMPANIES INC TJX
DRIL-QUIP, INC. DRQ
EDWARDS LIFESCIENCES CORP EW
AMTRUST FINANCIAL SERVICES INC AFSI
LUMBER LIQUIDATORS HOLDINGS INC LL
ALTISOURCE PORTFOLIO SOLUTIONS S.A. ASPS
LENDINGTREE INC TREE
Deletions  
NATIONAL-OILWELL VARCO, INC. NOV
SYNTEL, INC. SYNT
THOR INDUSTRIES, INC. THO
SANDERSON FARMS, INC. SAFM
POLARIS INDUSTRIES INC. PII
EPLUS INC. PLUS
TESORO CORPORATION TSO


Newcomers to the Validea Hot List

Altisource Portfolio Solutions S.A. (ASPS): This Luxembourg-based company provides real estate mortgage portfolio management and related technology products, as well as asset recovery and customer relationship management services. It serves government agencies, lenders, servicers, investors, mortgage bankers, credit unions, financial services companies and hedge funds across the U.S. It has a $500 million market cap. The stock gets strong interest from my Peter Lynch- and James O'Shaughnessy-based strategies. To read more about it, see the "Detailed Stock Analysis" section below.

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

AmTrust ($4.8 billion market cap) gets strong interest from my Peter Lynch-, Warren Buffett-, and James O'Shaughnessy-based models. To read more about its fundamentals, see the "Detailed Stock Analysis" section below.

Dril-Quip (DRQ): This Houston-based firm is a leading manufacturer of highly engineered offshore drilling and production equipment, which is well suited for use in deepwater, harsh environment and severe service applications. Earlier this year, the company announced that it had authorized a $100 million stock repurchase program with no set expiration date.

Oil-related stocks have been hit quite hard by the oil price plunge we have seen over the past year, and Dril-Quip ($2 billion market capitalization) is no exception. But my Benjamin Graham-, Peter Lynch-, and Warren Buffett-based strategies think it has been hit too hard. To read more about the company, scroll down to the "Detailed Stock Analysis" section below.

Edwards Lifesciences Corporation (EW): Edwards is focused on technologies that treat structural heart disease and critically ill patients. The company ($16 billion market capitalization) develops heart valve systems and repair products used to replace or repair a patient's diseased or defective heart valve.

Edwards gets strong interest from my Peter Lynch-based model and high marks from several other strategies. To read more about it, scroll down to the "Detailed Stock Analysis" section below.

LendingTree, Inc. (TREE): LendingTree operates an online loan marketplace for consumers to obtain an array of loan types and other credit-based offerings. It offers consumers tools and resources, including free credit scores, comparison-shopping tools, and services that match in-market consumers with multiple lenders.

LendingTree ($700 million market cap) gets high marks from my Motley Fool-based model. To read more about its fundamentals, see the "Detailed Stock Analysis" section below.

Lumber Liquidators Holdings (LL): This Virginia-based hardwood flooring retailer ($340 million market cap) has struggled mightily in the wake of allegations that the firm used wood products that had excessive levels of potentially dangerous chemicals in them. Investors have fled the stock in droves.

But my models think that investors have done what they often do when scandal or bad news hits: overreact. My Benjamin Graham- and Kenneth Fisher-based models think the stock has sunk to levels that now make it attractive. To read more about it, scroll down to the "Detailed Stock Analysis" section below.

The TJX Companies (TJX): The parent of Marshalls, T.J. Maxx, and HomeGoods, this Massachusetts-based firm offers brand-named clothing and merchandise at discount prices -- making it attractive when times are good or bad. The $45-billion-market-cap firm has taken in more than $30 billion in sales in the past year.

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

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will rebalance the portfolio. If you have any questions, please feel free to contact us at hotlist@validea.com.

Portfolio Holdings
Ticker Date Added Return
BMA 11/20/2015 -13.1%
VLO 11/20/2015 -6.5%
AFSI 1/15/2016 TBD
EW 1/15/2016 TBD
ASPS 1/15/2016 TBD
CALM 11/20/2015 -17.3%
LL 1/15/2016 TBD
TJX 1/15/2016 TBD
DRQ 1/15/2016 TBD
TREE 1/15/2016 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

BMA   |   VLO   |   AFSI   |   EW   |   ASPS   |   CALM   |   LL   |   TJX   |   DRQ   |   TREE   |  

BANCO MACRO SA (ADR)

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

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.

Detailed Analysis


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (12.69) relative to the growth rate (38.36%), 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 BMA (0.33) 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. BMA, whose sales are $1,307.0 million, needs to have a P/E below 40 to pass this criterion. BMA's P/E of (12.69) 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 BMA is 38.4%, 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

BMA 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. BMA's Equity/Assets ratio (15.00%) is very 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. BMA's ROA (4.30%) 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 BMA (7.91%) 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 BMA (-0.74%) 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.

VALERO ENERGY CORPORATION

Strategy: Contrarian Investor
Based on: David Dreman

Valero Energy Corp (Valero) is an international manufacturer and marketer of transportation fuels, other petrochemical products and power. The Company's refineries can produce conventional gasolines, premium gasolines, gasoline, diesel fuel, low-sulfur diesel fuel, ultra-low-sulfur diesel fuel, CARB diesel fuel, other distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products. The Company markets branded and unbranded refined products through approximately 7,400 outlets. The Company also owns 11 ethanol plants in the central plains region of the United States that primarily produce ethanol. The Company operates through two segments. The refining segment includes refining operations, wholesale marketing, product supply and distribution, and transportation operations in the United States, Canada, the United Kingdom, Aruba and Ireland. Its ethanol segment primarily includes sale of internally produced ethanol and distillers grains.

Detailed Analysis

MARKET CAP: PASS

Medium to large-sized companies (the largest 1500 companies) should be chosen, because they are more in the public eye. Furthermore, the investor is exposed to less risk of "accounting gimmickry", and companies of this size have more staying power. VLO has a market cap of $32,415 million, therefore passing the test.


EARNINGS TREND: PASS

A company should show a rising trend in the reported earnings for the most recent quarters. VLO's EPS for the past 2 quarters, (from earliest to most recent quarter) 2.64, 2.79 have been increasing, and therefore the company passes this test.


EPS GROWTH RATE IN THE IMMEDIATE PAST AND FUTURE: PASS

This methodology likes to see companies with an EPS growth rate higher than the S&P in the immediate past and a likelihood that this trend will continue in the near future. VLO passes this test as its EPS growth rate over the past 6 months (49.19%) has beaten that of the S&P (3.15%). VLO's estimated EPS growth for the current year is (24.82%), which indicates the company is expected to experience positive earnings growth. As a result, VLO passes this test.


This methodology would utilize four separate criteria to determine if VLO is a contrarian stock. In order to eliminate weak companies we have stipulated that the stock should pass at least two of the following four major criteria in order to receive "Some Interest".


P/E RATIO: PASS

The P/E of a company should be in the bottom 20% of the overall market. VLO's P/E of 7.08, based on trailing 12 month earnings, meets the bottom 20% criterion (below 10.73), and therefore passes this test.


PRICE/CASH FLOW (P/CF) RATIO: PASS

The P/CF of a company should be in the bottom 20% of the overall market. VLO's P/CF of 4.84 meets the bottom 20% criterion (below 5.51) and therefore passes this test.


PRICE/BOOK (P/B) VALUE: FAIL

The P/B value of a company should be in the bottom 20% of the overall market. VLO's P/B is currently 1.52, which does not meet the bottom 20% criterion (below 0.82), and it therefore fails this test.


PRICE/DIVIDEND (P/D) RATIO: FAIL

The P/D ratio for a company should be in the bottom 20% of the overall market (that is the yield should be in the top 20%). VLO's P/D of 33.67 does not meet the bottom 20% criterion (below 16.45), and it therefore fails this test.


This methodology maintains that investors should look for as many healthy financial ratios as possible to ascertain the financial strength of the company. These criteria are detailed below.


CURRENT RATIO: PASS

A prospective company must have a strong Current Ratio (greater than or equal to the average of it's industry [1.34] or greater than 2). This is one identifier of financially strong companies, according to this methodology. VLO's current ratio of 2.03 passes the test.


PAYOUT RATIO: PASS

A good indicator that a company has the ability to raise its dividend is a low payout ratio. The payout ratio for VLO is 15.50%, while its historical payout ratio has been 18.46%. Therefore, it passes the payout criterion.


RETURN ON EQUITY: PASS

The company should have a high ROE, as this helps to ensure that there are no structural flaws in the company. This methodology feels that the ROE should be greater than the top one third of ROE from among the top 1500 large cap stocks, which is 16.74%, and would consider anything over 27% to be staggering. The ROE for VLO of 23.14% is high enough to pass this criterion.


PRE-TAX PROFIT MARGINS: FAIL

This methodology looks for pre-tax profit margins of at least 8%, and considers anything over 22% to be phenomenal. VLO's pre-tax profit margin is 7.35%, thus failing this criterion.


YIELD: FAIL

The company in question should have a yield that is high and that can be maintained or increased. VLO's current yield is 2.97%, while the market yield is 2.93%. VLO fails this test.


LOOK AT THE TOTAL DEBT/EQUITY: PASS

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% or should be less than the average Debt/Equity for its industry of 46.58%. VLO's Total Debt/Equity of 34.62% is considered acceptable.

AMTRUST FINANCIAL SERVICES INC

Strategy: Growth Investor
Based on: Martin Zweig

Amtrust Financial Services, Inc. is an insurance holding company. Through its wholly owned subsidiaries, the Company 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. The Company operates through three segments. The Small Commercial Business segment provides workers' compensation and commercial package and other property and casualty insurance products. The Specialty Risk and Extended Warranty segment provides coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans. The Specialty Program segment provides workers' compensation, package products, general liability, commercial auto liability, excess and surplus lines programs and other specialty commercial property and casualty insurance.

Detailed Analysis


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. AFSI's P/E is 9.80, based on trailing 12 month earnings, while the current market PE is 14.00. 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. AFSI's revenue growth is 44.22%, while it's earnings growth rate is 30.29%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, AFSI 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 (14.7%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (9.8%) of the current year. Sales growth for the prior must be greater than the latter. For AFSI 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. AFSI's EPS ($2.17) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. AFSI's EPS for this quarter last year ($1.97) 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. AFSI's growth rate of 10.15% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: FAIL

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 AFSI is 15.14%. This should be less than the growth rates for the 3 previous quarters which are 7.32%, 46.83% and -37.59%. AFSI does not pass this test, which means that it does not have 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, 4.40%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 10.15%, (versus the same quarter one year ago) then the stock passes.


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

The EPS growth rate for the current quarter, 10.15% must be greater than or equal to the historical growth which is 30.29%. Since this is not the case AFSI 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. AFSI, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 1.95, 2.29, 2.34, 3.56 and 5.45, 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. AFSI's long-term growth rate of 30.29%, 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 AFSI, this criterion has not been met (insider sell transactions are 315, while insiders buying number 223). 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.

EDWARDS LIFESCIENCES CORP

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

Edwards Lifesciences Corporation is focused on technologies that treat structural heart disease and critically ill patients. The Company is engaged in the development and commercialization of heart valve therapies. It is a manufacturer of heart valve systems and repair products used to replace or repair a patient's diseased or defective heart valve. The Company develops hemodynamic monitoring systems used to measure a patient's cardiovascular function in the hospital setting. Patients in the hospital setting, including high-risk patients in the operating room or intensive care unit, are candidates for having their cardiac function or fluid levels monitored by the its Critical Care products. The Company's products and technologies it offers to treat advanced cardiovascular disease are categorized into three main areas: Transcatheter Heart Valve Therapy, Surgical Heart Valve Therapy and Critical Care.

Detailed Analysis


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (36.61) relative to the growth rate (42.72%), 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 EW (0.86) makes it 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. EW, whose sales are $2,440.6 million, needs to have a P/E below 40 to pass this criterion. EW's P/E of (36.61) is considered acceptable.


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 EW was 15.10% last year, while for this year it is 12.78%. Since inventory to sales has decreased from last year by -2.32%, EW 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 EW is 42.7%, 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: PASS

This methodology would consider the Debt/Equity ratio for EW (24.98%) to be acceptable (equity is three to 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 EW (5.55%) 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 EW (4.92%) 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.

ALTISOURCE PORTFOLIO SOLUTIONS S.A.

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

Altisource Portfolio Solutions S.A. is a provider of marketplace and transaction solutions for the real estate, mortgage and consumer debt industries offering both distribution and content. The Company operates in three segments: Mortgage Services, Financial Services and Technology Services. The Company's Mortgage Services segment provides services that span the mortgage and real estate lifecycle, and are outsourced by loan servicers, loan originators, investors and other sellers of single family homes. The Financial Services segment provides collection and customer relationship management services to debt originators and servicers, and the utility, insurance and hotel industries. The Company's Technology Services consists of REALSuite of software applications, Equator, LLC (Equator) software applications, Mortgage Builder software applications and its information technology (IT) infrastructure management services.

Detailed Analysis


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (6.72) relative to the growth rate (32.80%), 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 ASPS (0.20) 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. ASPS, whose sales are $1,037.5 million, needs to have a P/E below 40 to pass this criterion. ASPS's P/E of (6.72) 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 ASPS is 32.8%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is acceptable.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

ASPS 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. ASPS'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. ASPS's ROA (11.01%) 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 ASPS (20.18%) 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 ASPS (-70.20%) 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.

CAL-MAINE FOODS INC

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

Cal-Maine Foods, Inc. is a producer and marketer of shell eggs in the United States. The Company's primary business is the production, grading, packaging, marketing and distribution of shell eggs. The Company sells its shell eggs in the southwestern, southeastern, mid-western and mid-Atlantic regions of the United States. The Company markets its shell eggs through its distribution network to a group of customers, including national and regional grocery store chains, club stores, foodservice distributors and egg product consumers. Some of its sales are completed through co-pack agreements. It has a total flock of approximately 33.7 million layers and 8.4 million pullets and breeders. The Company markets its specialty shell eggs under brands, such as Egg-Land's Best, Land O' Lakes, Farmhouse and 4-Grain. The Company also produces, markets and distributes private label specialty shell eggs to several customers.

Detailed Analysis


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical (non-Smokestack) companies with Price/Sales ratio between .75 and 1.5 are good values. CALM's P/S ratio of 1.14 based on trailing 12 month sales, falls within the "good values" range for non-cyclical companies and is considered attractive.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. CALM's Debt/Equity of 3.30% 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. CALM 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 CALM At this Point

Is CALM a "Super Stock"? NO


PRICE/SALES RATIO: FAIL

The prospective company should have a low Price/Sales ratio. To be considered a "Super Stock", non-cyclical (non-Smokestack) companies should have Price/Sales ratios below .75. However, CALM, who has a P/S of 1.14, does not fall within the "Super Stock" range. It does fall between 0.75 and 1.5, which is considered the "good values" range for non-cyclical companies. Nonetheless, it does not pass this "Super Stock" criterion.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. CALM's inflation adjusted EPS growth rate of 19.95% 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. CALM's free cash per share of 1.32 passes this criterion.


THREE YEAR AVERAGE NET PROFIT MARGIN: PASS

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. CALM, whose three year net profit margin averages 7.24%, passes this evaluation.

LUMBER LIQUIDATORS HOLDINGS INC

Strategy: Value Investor
Based on: Benjamin Graham

Lumber Liquidators Holdings, Inc. (Lumber Liquidators) is a retailer of hardwood flooring, and hardwood flooring enhancements and accessories in North America. The Company's product categories include Solid and Engineered Hardwood; Laminate; Bamboo, Cork and Vinyl Plank, and Moldings and Accessories. The Company sells its products primarily to homeowners or to contractors on behalf of homeowners. The Company offers wood flooring under18 brand names, led by Bellawood, a collection of solid and engineered hardwood flooring, bamboo flooring, moldings and accessories. The Company also offers a range of flooring enhancements and installation accessories, including moldings, noise-reducing underlay and tools. It offers around 400 different flooring product stock-keeping units. As of February 23, 2015, Lumber Liquidators operated around 354 stores located in 46 states of the United States and nine store locations in Canada.

Detailed Analysis


SECTOR: PASS

LL 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. LL's sales of $1,015.9 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. LL's current ratio of 2.55 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 LL is $0.0 million, while the net current assets are $205.1 million. LL passes this test.


LONG-TERM EPS GROWTH: PASS

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. Companies with this type of growth tend to be financially secure and have proven themselves over time. LL's EPS growth over that period of 436.5% passes the EPS growth test.


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. LL's P/E of 5.60 (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. LL's Price/Book ratio is 1.15, while the P/E is 5.60. LL passes the Price/Book test.

TJX COMPANIES INC

Strategy: Patient Investor
Based on: Warren Buffett

The TJX Companies, Inc. (TJX) is an off-price apparel and home fashions. The Company operates through four segments: Marmaxx, HomeGoods, TJX Canada and TJX Europe. The Marmaxx and HomeGoods business offers family apparel, home fashions, accent furniture, lamps, rugs, wall decor, decorative accessories and giftware and other merchandise. The TJX Canada offers jewelry and home fashions. TJX Europe operates the T.K. Maxx and HomeSense chains in Europe. The Company operates approximately 3,461 stores in countries, including the United States, Canada, the United Kingdom, Ireland, Germany, Poland, Austria and Australia.

Detailed Analysis

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 0.71, 0.82, 0.84, 1.04, 1.42, 1.65, 1.93, 2.55, 2.94, 3.15. Buffett would consider TJX's earnings predictable. In fact EPS have increased every year. TJX's long term historical EPS growth rate is 17.5%, based on the average of the 3, 4 and 5 year historical eps growth rates, and it is expected to grow earnings 11.0% 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. TJX has a debt of 1,624.0 million and earnings of 2,233.7 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 TJX, over the last ten years, is 39.6%, 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 34.4%, 32.7%, 33.8%, 40.2%, 40.2%, 41.4%, 45.0%, 50.4%, 49.1%, 50.6%, and the average ROE over the last 3 years is 50.0%, 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 TJX, over the last ten years, is 32.3% and the average ROTC over the past 3 years is 38.6%, 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 24.1%, 24.2%, 24.1%, 34.1%, 31.6%, 33.0%, 36.2%, 41.6%, 37.7%, 36.6%, 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. TJX's free cash flow per share of $2.32 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 $13.79 and compares it to the gain in EPS over the same period of $2.44. TJX's management has proven it can earn shareholders a 17.7% 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. TJX's shares outstanding have fallen over the past five years from 779,320,007 to 681,000,000, 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 TJX 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 $3.28 and divide it by the current market price of $68.47. An investor, purchasing TJX, could expect to receive a 4.79% initial rate of return. Furthermore, he or she could expect the rate to increase 11.0% 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 TJX's initial yield of 4.79%, which will expand at an annual rate of 11.0%, 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]

TJX currently has a book value of $6.50. It is safe to say that if TJX can preserve its average rate of return on equity of 39.6% and continues to retain 79.67% of its earnings, it will be able to sustain an earnings growth rate of 31.5% and it will have a book value of $100.81 in ten years. If it can still earn 39.6% on equity in ten years, then expected EPS will be $39.92.


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

Now take the expected future EPS of $39.92 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (20.9) (5 year average P/E in this case), which is 18.5 and you get TJX's projected future stock price of $738.49.


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 $12.38. This gives you a total dollar amount of $750.87. These numbers indicate that one could expect to make a 27.1% average annual return on TJX'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 11.0%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $9.31. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio or current P/E ratio (20.9) (5 year average P/E in this case), which is 18.5. This equals the future stock price of $172.30. Add in the total expected dividend pool of $12.38 to get a total dollar amount of $184.67.


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 $68.47 and the future expected stock price, including the dividend pool, of $184.67. If you were to invest in TJX at this time, you could expect a 10.43% average annual return on your money. Buffett likes to see a 15% return, and would even go down to 12%.


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 10.4% and 27.1%. 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 18.7% on TJX stock for the next ten years, based on the current fundamentals. Buffett would consider this a great return, thus passing the criterion.

DRIL-QUIP, INC.

Strategy: Patient Investor
Based on: Warren Buffett

Dril-Quip, Inc. designs, manufactures, sells and services engineered offshore drilling and production equipment. The Company's equipment is suited for use in deepwater, harsh environments and service applications. The Company's operates in Western Hemisphere, including North and South America; Eastern Hemisphere, including Europe and Africa and Asia-Pacific, including the Pacific Rim, Southeast Asia, Australia, India and the Middle East. It products include subsea equipment, surface equipment and offshore rig equipment. Its products are used to explore for oil and gas from offshore drilling rigs, such as floating rigs and jack-up rigs, and for drilling and production of oil and gas wells on offshore platforms, TLPs, Spars and moored vessels, such as FPSOs. Its services include technical advisory assistance services, reconditioning of its customer-owned products, and rental of running tools for installation and retrieval of its products.

Detailed Analysis

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 0.90, 2.15, 2.63, 2.62, 2.66, 2.55, 2.36, 2.94, 4.16, 5.19. Buffett would consider DRQ's earnings predictable, although earnings have declined 3 time(s) in the past seven years, with the most recent decline 4 years ago. The dips have totaled 12.0%. DRQ's long term historical EPS growth rate is 21.1%, based on the average of the 3, 4 and 5 year historical eps growth rates.


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. DRQ has no long term debt and therefore would pass this criterion.


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 DRQ, over the last ten years, is 14.4%. Although he prefers ROE to be 15% or higher, this level is acceptable to Buffett. 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 10.5%, 18.6%, 18.1%, 18.3%, 15.0%, 12.3%, 10.3%, 11.2%, 13.7%, 16.2%, and the average ROE over the last 3 years is 13.7%, 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 DRQ, over the last ten years, is 14.4% and the average ROTC over the past 3 years is 13.7%, 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 10.4%, 18.5%, 18.1%, 18.3%, 15.0%, 12.3%, 10.3%, 11.2%, 13.7%, 16.2%, 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. DRQ's free cash flow per share of $2.66 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 $28.16 and compares it to the gain in EPS over the same period of $4.29. DRQ's management has proven it can earn shareholders a 15.2% 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. DRQ's shares outstanding have fallen over the past five years from 40,040,001 to 39,000,000, 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 DRQ 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 $5.20 and divide it by the current market price of $55.19. An investor, purchasing DRQ, could expect to receive a 9.42% initial rate of return. Furthermore, he or she could expect the rate to increase 21.1% per year, based on the average of the 3, 4 and 5 year historical eps growth rates, 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 DRQ's initial yield of 9.42%, which will expand at an annual rate of 21.1%, based on the average of the 3, 4 and 5 year historical eps growth rates. 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]

DRQ currently has a book value of $34.28. It is safe to say that if DRQ can preserve its average rate of return on equity of 13.7% and continues to retain 100.00% of its earnings, it will be able to sustain an earnings growth rate of 13.7% and it will have a book value of $123.67 in ten years. If it can still earn 13.7% on equity in ten years, then expected EPS will be $16.93.


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

Now take the expected future EPS of $16.93 and multiply them by the lower of the 5 year average P/E ratio (23.4) or current P/E ratio (current P/E in this case), which is 10.6 and you get DRQ's projected future stock price of $179.46.


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 $0.00. This gives you a total dollar amount of $179.46. These numbers indicate that one could expect to make a 12.5% average annual return on DRQ's stock at the present time. Although, the return is slightly below the liking of Buffett, the return would still be somewhat acceptable.


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

If you take the EPS growth of 21.1%, based on the average of the 3, 4 and 5 year historical eps growth rates, you can project EPS in ten years to be $35.41. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio (23.4) or current P/E ratio (current P/E in this case), which is 10.6. This equals the future stock price of $375.34. Add in the total expected dividend pool of $0.00 to get a total dollar amount of $375.34.


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 $55.19 and the future expected stock price, including the dividend pool, of $375.34. If you were to invest in DRQ at this time, you could expect a 21.13% average annual return on your money. Buffett would consider this a great 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 12.5% and 21.1%. 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 16.8% on DRQ stock for the next ten years, based on the current fundamentals. Buffett would consider this a great return, thus passing the criterion.

LENDINGTREE INC

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

LendingTree, Inc. (LendingTree), formerly Tree.com, Inc. is engaged in operating an online loan marketplace for consumers an array of loan types and other credit-based offerings. The Company offers consumers tools and resources, including free credit scores, which help them to comparison-shop for mortgage loans, home equity loans and lines of credit, reverse mortgages, personal loans, auto loans, student loans, credit cards, small business loans and other related offerings. And, upon submitting their relevant information to the Company through an inquiry form, it seeks to match in-market consumers with multiple lenders on its marketplace. The Company operates in four segments: lending, auto, education and home services. It provides information and tools, including free credit scores located on its various Websites. In addition, the Company provides consumers with access to offers from multiple lenders.

Detailed Analysis


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. TREE's profit margin of 9.71% 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. TREE, with a relative strength of 92, satisfies this test.


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

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 TREE (1,080.00% for EPS, and 68.97% for Sales) are good enough to pass.


INSIDER HOLDINGS: PASS

TREE's insiders should own at least 10% (they own 40.66% ) of the company's outstanding shares which is extremely attractive since the minimum requirement is 10%. A high percentage indicates that the insiders are confident that the company will do well.


CASH FLOW FROM OPERATIONS: FAIL

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. TREE's free cash flow of $-0.41 per share fails this test.


PROFIT MARGIN CONSISTENCY: FAIL

The profit margin in the past must be consistently increasing. The profit margin of TREE has been inconsistent in the past three years (Current year: 5.59%, Last year: 2.84%, Two years ago: 60.20%), which is unacceptable. This inconsistency will carryover directly to the company's bottom line, or earnings per share.


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 TREE's case.


CASH AND CASH EQUIVALENTS: PASS

TREE's level of cash $86.2 million passes this criteria. If a company is a cash generator, like TREE, it has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash.


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 TREE was 9.23% last year, while for this year it is 8.13%. Since the AR to sales is decreasing by -1.10% the stock passes this criterion.


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

The "Fool Ratio" is an extremely important aspect of this analysis. Unfortunately, TREE's "Fool Ratio" is not available due to a lack of one or more important figures. Hence, an opinion cannot be given at this time.

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

AVERAGE SHARES OUTSTANDING: PASS

TREE has not been significantly increasing the number of shares outstanding within recent years which is a good sign. TREE currently has 12.0 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. TREE's sales of $219.7 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". TREE passes the sales test.


DAILY DOLLAR VOLUME: FAIL

TREE does not pass the Daily Dollar Volume (DDV of $41.2 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. TREE with a price of $66.24 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

TREE's income tax paid expressed as a percentage of pretax income this year was (49.48%) and last year (39.82%) 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.


Watch List

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