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Executive Summary June 11, 2010

The Economy

It's been another topsy-turvy fortnight for the markets, as investors have responded to economic reports that have ranged from quite positive to quite disappointing.

At the forefront of the economic news: unemployment. After four straight months of job growth -- which included about half a million jobs being added over the past two months -- the economy added just 41,000 private sector jobs in May, according to the Labor Department. All in all, 431,000 jobs were added, but 411,000 involved temporary hires for Census 2010.

This week, however, another report showed that ongoing claims for unemployment benefits dropped sharply in the week ending May 29, falling more than 5%. But it's unclear how much of that was due to people getting work, or due to unemployed workers exhausting their benefits, or giving up on looking for work.

These unemployment numbers have been dissected in a myriad of different ways since they were released. Some point out that while the unemployment rate dipped slightly, that was due to the temporary Census jobs -- and that the rate doesn't include many discouraged workers who have given up looking for jobs. Others point out that those who do have jobs are working longer hours and earning more, as average workweeks and wages both grew in May. That could be a precursor to more significant job growth.

It's always hard to decide what to take from individual jobs reports. But from a broader perspective, the trend continues to be encouraging. We've now had job growth in five straight months, and six in the last seven.

Other economic news also continues to be encouraging. The Institute for Supply Management reported that the manufacturing sector expanded for the 10th straight month in May. New orders increased for the 11th straight month, and the group's employment index grew at an accelerating rate in May, the sixth straight month it has indicated growth in employment.

ISM's service sector report also showed growth in May, for the sixth straight month. And, importantly, it said employment activity increased in the sector for the first time in 28 months. With so much of U.S. economic activity driven by service industries, that's a very good sign.

A new Commerce Department report, meanwhile, showed that factory orders increased in April by 1.2%. The figure was below analysts' expectations, but the growth is nonetheless a welcome sign.

And there was good news in the housing department, as pending home sales increased by 6% in April, the National Association of Realtors reported. It was the third straight month of gains, and was driven by the government homebuyer tax credit, improved consumer confidence, and low mortgage rates, the group said.

Outside of the U.S., the turmoil in Europe continues. Since our last newsletter, Hungary has been added to the list of countries faced with major debt woes. But some good news about the European debt crisis came from Asia this week. Exports and imports both surged more than 48% in May in China. The fact that those figures jumped amid the crisis in Europe -- which is China's largest trading partner -- was seen by many as a sign that the Euro troubles won't derail the global economic recovery.

As investors digested all of that news, the S&P 500 ended the past fortnight with a return of -1.5%, while the Hot List returned -3.9%. For the year, the portfolio is now down -6.5% vs. -2.5% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 125.4% vs. the S&P's 8.6% gain.

Thinking Outside the Style Box

As investors regroup amid the current correction, there's a lot of talk about which area of the market will lead the next leg up. Some say that large stocks are poised for a good run, given their underperformance compared to smaller stocks over the past decade or so. Others say high-dividend value plays are the place to be. It's a discussion that you can find in just about any market -- investment publications and pundits are always pitting value stocks against growth stocks, and large-caps against small-caps.

There is value (pardon the pun) to style-box categories. Institutions that need to have a particular percentage of their investments in certain size or style stocks surely make good use of them, for example. And style-box categories that have been out of favor for long periods of time may present investors with buying opportunities.

But in the dozen or so years I've spent studying history's most successful investment strategies, I've found that paying too much attention to such style-box distinctions can be harmful to your returns. And, when it comes to growth vs. value, I've found that an "either/or" approach often misses the boat.

I was recently reminded of this while reading through one of Warren Buffett's past letters to Berkshire Hathaway shareholders. In his 2000 letter, Buffett wrote that "market commentators and investment managers who glibly refer to 'growth' and 'value' styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component -- usually a plus, sometimes a minus -- in the value equation."

"Indeed," Buffett said, "growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years."

To Buffett, growth and value aren't polar opposites; instead, the rate at which a company is growing is just one factor involved in determining the true value of a stock. A company can be growing like gangbusters, but if its shares are overpriced, or it is using large amounts of leverage to produce that growth, it's likely not worth your attention.

Buffett isn't the only guru who thinks along those lines. In fact, most of the investors upon whom I base my Guru Strategies used a mixture of growth-related variables and valuation-related variables. Growth-focused Martin Zweig, for example, also used the price/earnings ratio in his analysis of stocks -- he was willing to pay a premium for growth, but not too much. John Neff was a self-described "low-P/E investor", but he also wanted companies to be growing earnings at a nice, sustainable pace (my Neff-based model looks for growth between 7% and 20% per year). Peter Lynch actually incorporated growth and value into one innovative variable -- the P/E/Growth ratio, which divides a stock's P/E by its historical growth rate. The rationale: The faster the rate at which a company is growing earnings, the more you should be willing to pay for every dollar of those earnings.

Other gurus upon whom I base my models -- Kenneth Fisher, David Dreman, James O'Shaughnessy, and even the "Father of Value Investing", Benjamin Graham -- used both growth and value tests in their approaches. That's evident right now in looking at the Hot List, which uses these gurus' strategies to pick its holdings.

For example, consider AstraZeneca, the healthcare/pharmaceutical company. On the surface, AstraZeneca appears to be a clear value stock -- it sells for just 7.6 times trailing 12-month earnings, and it's yielding about 8%. But the company also has an impressive growth story. It has increased earnings per share in 8 of the past 10 years, and in the financial-crisis-marred years of 2008 and 2009 it grew EPS by 12% and 24%, respectively.

Another Hot List holding that has characteristics traditionally associated with both growth and value stocks is HealthSpring, a niche healthcare firm that specializes in Medicare Advantage offerings. HealthSpring has growing earnings quite rapidly -- it has upped EPS in each of the past four years and seven of the past eight, and over the long term is growing earnings at a 46% clip. But it's also a bargain, as investors leery of the healthcare bill's Medicare cutbacks have been avoiding this proven performer. It sells for just 6.3 times trailing 12-month earnings, 0.34 times sales, and 0.99 times book value.

AstraZeneca and HealthSpring are both examples of very well-rounded stocks that are solid across a number fundamental levels, which are the types of stocks that tend to do well over the long haul. By using both growth and value metrics, you can identify these type of plays. If you constrain yourself to looking at only growth variables or only valuation metrics, however, you run the risk of getting saddled with two types of stocks that can cause big damage to your portfolio: hot, overpriced growth stocks that have unrealistic expectations priced into their shares (think back to the tech bubble); and so-called "value traps" -- stocks that appear to be cheap, but which are really dogs (think about some of the weaker financial firms whose shares appeared cheap during the '08 collapse -- and then went to zero as the firms crumbled under the weight of their debt).

Just as it's important not to constrain yourself by growth/value characterizations, we also believe it's important not to limit yourself by size, industry, or sector. We allow the Hot List to roam the entire market to find where the best buys are. At any given time, those great buys could come primarily from small-caps, large-caps, or mid-caps; the bulk of them could also come from a couple -- or even just one -- particularly attractive industry or sector.

Because a strategy that has free range can become concentrated in a particular area of the market that it finds to be value-rich, discipline is key. By rebalancing its holdings every month, the Hot List has the ability to capitalize when certain areas of the market become particularly undervalued, while ensuring that it doesn't get locked into those areas if at some point they become overvalued or their fundamentals deteriorate. And as other areas become more attractive, it has the freedom to pursue them at the next rebalancing. I think that combination of a "free-range" approach to picking stocks and a disciplined rebalancing period is a big reason why the Hot List has had so much success over the long term. And I think it's a combination that will continue to serve the portfolio well in the months and years to come.

 
Editor-in-Chief: John Reese










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The Fallen

As we rebalance the Validea Hot List, 3 stocks leave our portfolio. These include: Federal Agricultural Mortgage Corp. (AGM), Lincoln Educational Services Corporation (LINC) and Gamestop Corp. (GME).

The Keepers

7 stocks remain in the portfolio. They are: Oshkosh Corporation (OSK), Astrazeneca Plc (Adr) (AZN), Aeropostale, Inc. (ARO), China Automotive Systems, Inc. (CAAS), Ares Capital Corporation (ARCC), Healthspring, Inc (HS) and Clearwater Paper Corp (CLW).

The Newbies

We are adding 3 stocks to the portfolio. These include: Jos. A. Bank Clothiers, Inc. (JOSB), Sanofi-aventis Sa (Adr) (SNY) and Aixtron Ag (Adr) (AIXG).

Portfolio Changes



Newcomers to the Validea Hot List

Jos. A. Bank Clothiers (JOSB): Based in Hampstead, Maryland, this prior Hot List favorite is once again catching the portfolio's eye. The 100-plus-year-old retailer sells a variety of men's tailored, casual, and sports clothing, as well as shoes and accessories such as hats and belts. The small-cap ($1.0 billion market cap), has more than 475 stores across the U.S.

Bank, which has had several previous stints in the Hot List -- including one in which it gained 78.2% from Feb. 20 to Oct. 2 of 2009 -- gets strong interest from my James O'Shaughnessy growth model and my Warren Buffett-based strategy. To find out more about the stock's fundamentals, see the "Detailed Stock Analysis" section below.

Sanofi-Aventis SA (SNY): Headquartered in Paris with operations in more than 100 countries, Sanofi makes a wide array of drugs, including Allegra (allergies), Ambien CR (a prescription sleeping aid), and Plavix (used to prevent blood clots). The $76 billion market cap firm has taken in more than $37 billion in sales in the past year.

Sanofi-Aventis gets strong interest from my Benjamin Graham-, Peter Lynch-, and James O'Shaughnessy-based models. To read more about the stock, check out the "Detailed Stock Analysis" section below.

AIXTRON AG (AIXG): This Germany-based technology firm makes components for electronic and opto-electronic applications. Its products are are used in display technology, signal and lighting technology, fiber communication networks, wireless and cell telephony applications, optical and electronic data storage, computer technology, and a range of other high-tech applications. The firm has a $2.4 billion market cap.

AIXTRON gets high marks from the models I base on the writings of Martin Zweig and Tom and David Gardner of The Motley Fool. To read more about the stock, see the "Detailed Stock Analysis" section below.



News about Validea Hot List Stocks

AstraZeneca PLC (AZN): On June 7, AstraZeneca said trials have shown its vandetanib drug cut the rate of disease progression by 54% in thyroid cancer patients during a late-stage study. The results met the key study goal of progression-free survival, or the amount of time patients survive without the condition progressing, the Associated Press reported.

Aeropostale Inc. (ARO): Same-store sales increased 1% in May (vs. the same month a year ago) for the retailer, according to the Associated Press. The data involves stores open at least one year.



The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will examine one of my individual Guru Strategies in greater depth. If you have any questions, please feel free to contact us at hotlist@validea.com.



Current Portfolio






Detailed Stock Analysis

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

JOSB   |   AZN   |   HS   |   OSK   |   ARO   |   CLW   |   AIXG   |   CAAS   |   SNY   |   ARCC   |  



Jos. A. Bank Clothiers, Inc. (Jos. A. Bank) is a designer, manufacturer, retailer and direct marketer (through stores, catalog and Internet) of men's tailored and casual clothing and accessories. The Company sells substantially all of its products exclusively under the Jos. A. Bank label through its 473 retail stores (as of January 30, 2010, which includes seven outlet stores and 13 franchise stores) located throughout 42 states and the District of Columbia in the United States, as well as through the Company's nationwide catalog and Internet (www.josbank.com) operations. Jos. A. Bank operates through two segments: Stores and Direct Marketing. The Company's Stores segment consists of its 453 Full-line Stores. The Company opened 14 stores (and closed one store) during the fiscal year ended January 30, 2010 (fiscal 2009). The Company's Direct Marketing segment consists of its Internet and catalog channels.





AstraZeneca PLC (AstraZeneca) is a biopharmaceutical company. The Company focuses on the discovery, development and commercialization of prescription medicines for six areas of healthcare. Its six areas of healthcare includes cardiovascular, gastrointestinal, infection, neuroscience, oncology, and respiratory and inflammation. The Company's products include Crestor, Nexium, Synagis, Seroquel, Arimidex and Symbicort. The Company owns and operates a range of research and development (R&D), production and marketing facilities worldwide.





HealthSpring, Inc. (HealthSpring) is a managed care organization with a primary focus on Medicare, the federal government-sponsored health insurance program for United States citizens aged 65 and older, qualifying disabled persons and persons suffering from end-stage renal disease. As of December 31, 2009, the Company operated coordinated care Medicare Advantage plans in Alabama, Florida, Illinois, Mississippi, Tennessee, and Texas. As of January 1, 2010, it also commenced operations of Medicare Advantage plans in three counties in Northern Georgia. As of December 31, 2009, the Company's Medicare Advantage plans had over 189,000 members. The Company also offers prescription drug benefits in accordance with Medicare Part D to its Medicare Advantage plan members, in addition to providing other medical benefits (MA-PD) plans. It also offers prescription drug benefits nationally on a stand-alone basis in accordance with Medicare Part D (PDP).





Oshkosh Corporation (Oshkosh) is a designer, manufacturer and marketer of a range of specialty vehicles and vehicle bodies, including defense trucks, access equipment, fire & emergency vehicles and concrete mixers and refuse collection vehicles. The Company operates in four business segments: defense, access equipment, fire & emergency, and commercial. It manufactures defense trucks under the Oshkosh brand name, and is a manufacturer of severe-duty heavy- and medium-payload tactical trucks for the United States Department of Defense (DoD). The Company is also the manufacturer of aerial work platforms under the JLG brand name. Under the Pierce brand name, the Company manufactures fire apparatus assembled on both custom and commercial chassis. The Company manufactures aircraft rescue and fire fighting (ARFF) and airport snow removal vehicles under the Oshkosh brand name and ambulances under the Medtec brand name.





Aeropostale, Inc. is a mall-based specialty retailer of casual apparel and accessories. The Company designs, markets and sells its own brand of merchandise principally targeting 14 to 17 year-old young women and young men. The Company also sells Aropostale merchandise through its e-commerce Website, www.aeropostale.com. During the fiscal year ended January 30, 2010 (fiscal 2009), the Company launched P.S. from Aeropostale, which offers casual clothing and accessories focused on elementary school children between the ages of 7 and 12. During fiscal 2009, the Company completed the closure of its 14 store Jimmy'Z concept. Jimmy'Z Surf Co., Inc., a wholly owned subsidiary of Aeropostale, Inc., was a contemporary lifestyle brand targeting young women and men aged 18 to 25.





Clearwater Paper Corporation is a producer of tissue and paperboard products in the United States. The Company's products are manufactured in the United States and utilize primarily wood pulp. The Company operates in three segments: Consumer Products, Pulp and Paperboard, and Wood Products. Its private label tissue products, such as facial and bath tissue, paper towels and napkins, are used at home and are principally sold in grocery stores in the United States. The Company's paperboard is sold in the packaging industry and it is used by its customers to make packaging for products, including liquids, pharmaceuticals, consumer goods packaging. The Company is vertically integrated and produces the pulp required in its tissue and paperboard businesses. The Company also manufactures wood products, including cedar and lumber products.





AIXTRON AG (AIXTRON) is a provider of deposition equipment to the semiconductor industry. The Company's technology solutions are used by a range of customers worldwide to build advanced components for electronic and opto-electronic applications based on compound, silicon, or organic semiconductor materials. Such components are used in displays, signaling, lighting, fiber optic communication systems, wireless and mobile telephony applications, optical and electronic storage devices, computing, as well as a range of other leading-edge technologies. AIXTRON's business activities include developing, producing and installing equipment for coating semiconductor materials, process engineering, consulting and training, including ongoing customer support. AIXTRON supplies to customers both full production-scale material deposition systems and small scale systems for Research and Development (R&D) use and small-scale production use.





China Automotive Systems, Inc. (China Automotive) is a holding company and has no significant business operations or assets other than its interest in Great Genesis Holdings Limited (Genesis). Through Genesis, the Company manufactures power steering systems and other component parts for automobiles. All operations are conducted through eight Sino-foreign joint ventures in China and a wholly owned subsidiary in the United States. The Company has business relations with more than 60 vehicle manufacturers, including FAW Group and Dongfeng Auto Group, automobile manufacturers in China; Shenyang Brilliance Jinbei Co., Ltd., light vehicle manufacturer in China; Chery Automobile Co., Ltd, state-owned car manufacturer in China, and Xi'an BYD Auto Co., Ltd and Zhejiang Geely Automobile Co., Ltd., car manufacturers.





Sanofi-Aventis is a pharmaceutical group engaged in the research, development, manufacture and marketing of healthcare products. The Company's business includes two main activities: pharmaceuticals and human vaccines through sanofi pasteur. The Company is also present in animal health products through Merial Limited (Merial). In its pharmaceutical activity, the Company specializes in six therapeutic areas: diabetes, oncology, thrombosis and cardiovascular, central nervous system (CNS), and internal medicine. The global portfolio of sanofi-aventis also consists of a range of other pharmaceutical products in Consumer Health Care (CHC) and other prescription drugs, including generics. It offers vaccines in five areas: pediatric combination vaccines, influenza vaccines, adult and adolescent booster vaccines, meningitis vaccines and travel and endemic vaccines.





Ares Capital Corporation (Ares Capital) is a specialty finance company, which is a closed-end, non-diversified management investment company. Ares Capital's investment objective is to generate both current income and capital appreciation through debt and equity investments. It invests in United States middle-market companies. It invests primarily in first and second lien senior loans and mezzanine debt, which in some cases includes an equity component like warrants. First and second lien senior loans generally are senior debt instruments that rank ahead of subordinated debt of a given portfolio company. Its investments have ranged between $10 million and $100 million each, although the investment sizes may be more or less than the targeted range. The Company's investment adviser is Ares Capital Management LLC. In April 2010, Ares Capital Corporation completed its merger with Allied Capital Corporation.





Watch List

The Watch List contains the highest scoring stocks according to our guru consensus system that are not currently in the Hot List portfolio. We provide this list both for informational purposes and for investors who are not comfortable with a portfolio of ten stocks.





Disclaimer


The names of individuals (i.e., the 'gurus') appearing in this report are for identification purposes of his methodology only, as derived by Validea.com from published sources, and are not intended to suggest or imply any affiliation with or endorsement or even agreement with this report personally by such gurus, or any knowledge or approval by such persons of the content of this report. All trademarks, service marks and tradenames appearing in this report are the property of their respective owners, and are likewise used for identification purposes only.

Validea is not registered as a securities broker-dealer or investment advisor either with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. Validea is not responsible for trades executed by users of this site based on the information included herein. The information presented on this website does not represent a recommendation to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment. The information on this website is generic by nature and is not personalized to the specific situation of any individual. The user therefore bears complete responsibility for their own investment research and should seek the advice of a qualified investment professional prior to making any investment decisions.

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