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Executive Summary February 15, 2013

The Economy

Just as it did for most of 2012, the economy is continuing to make steady gains as we move deeper into 2013 -- and as it does, the stock market is creeping closer and closer to all-time highs.

Since our last newsletter, several solid economic reports have been released. The Labor Department, for example, said the private sector added 166,000 jobs in January. It also released revised 2012 data showing that total nonfarm payrolls increased by 335,000 more than previous estimates, meaning that the economy added about 2.25 million private sector jobs in 2012. Both the headline unemployment rate (7.9%) and the broader "U-6" rate (14.4%) held steady for the month.

New claims for unemployment dropped rather sharply in the most recent week. But there continues to be a bit of a strange relationship between the seasonally adjusted and unadjusted data. While adjusted new claims fell by more than 7% from the previous week, on an unadjusted basis they were only about 1.5% below their year-ago level -- worse than the previous week's 3.2% figure.

Manufacturing activity, meanwhile, picked up in January, according to the Institute for Supply Management. ISM's manufacturing index showed that the sector expanded in January at its fastest pace since last April. The new orders and employment sub-indices both made nice jumps as well.

The service sector also expanded in January, the 37th straight month it has done so, according to ISM. The rate of expansion was about the same as it was the previous month.

Decent news also came from the consumer sector. Retail and food service sales increased 0.1% (seasonally adjusted) in January, according to a new Commerce Department report. While the month-over-month gain was minor, the data also showed that sales were 6.2% higher than they were in the same month last year, using unadjusted data. In the previous month that year-over-year increase had fallen to 2.5%, so this was a nice rebound.

Real disposable personal income jumped sharply in December, according to new data from the Commerce Department, rising 2.8%. Consumers saved most of that additional income, with the personal savings rate surging from 4.1% to 6.5%, its highest level in nearly three years. But a big reason behind the jump seems to have been the fact that many companies sped up their dividend payments, in expectation of the dividend tax increase that went into effect as part of the fiscal cliff negotiations. It probably is unwise to draw any long-term conclusions from the data.

Corporate earnings announcements for the fourth quarter are also continuing to roll in, and all in all the results have been decent. With about two-thirds of companies in the S&P 500 having reported, about 65% have beaten analysts' estimates so far, a rate pretty similar to what we've seen in the past couple years.

Since our last newsletter, the S&P 500 returned 1.6%, while the Hot List returned 2.2%. So far in 2013, the portfolio has returned 7.1% vs. 6.7% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 190.4% vs. the S&P's 52.1% gain.

What It Takes To Win Over The Long Run

There aren't many places you can go 2013 without being made aware of what the stock market did today. Even if you're not plugged into 24-hour financial news networks and not continually logged onto financial websites (which many people are), you'll still get important-sounding updates on the radio or nightly news: "the Dow fell 82 points today," a newscaster might say in a grave voice, making the information sound all the more meaningful. Of course, the day-to-day shifts in your own portfolio can seem even more meaningful, because it's your money that's going up and down.

But the truth is that day-to-day fluctuations in stock prices on the whole really aren't that meaningful. In fact, there is evidence that paying a lot of attention to those movements doesn't make you a better, more conscientious investor; it actually hurts you over the long haul. In an article written for the American Association of Individual Investors a couple years back, Mark Hulbert noted that, "According to behavioral finance researchers, constantly looking at how your portfolio is performing is not a benign act. It leads you to focus more of your attention on the short term than you would otherwise, leading you in turn to miss the veritable forest for the trees."

Hulbert referenced a study performed by a pioneer of behavioral finance, University of Chicago Professor Richard Thaler. In the 1997 study -- "The Effect of Myopia and Loss Aversion" -- Thaler, Amos Tversky, Daniel Kahneman, and Alan Schwartz had a group of undergraduate students simulate investment decisions, and told them that they would be paid (between $5 and $30) depending on their actual investment success or failure. As part of the study, different students were allowed to check their portfolios at differing time intervals. Who did better? Well, those who were allowed to look at their portfolios the most actually did the worst. They tended to put less money into stocks and more into bonds, which are traditionally thought of as "safer" investments even though stocks clearly outperform them over the long term. "The subjects with the most data did the worst in terms of money earned," the study results stated, "since those with the most frequent data invested the least in stocks (and thus earned the least)."

In examining the historical performance of the Hot List and our other top-performing guru-based portfolios, I recently found some interesting evidence that shows why a day-to-day, hyperfocused investment approach can get you in trouble. Going back to their inceptions, I looked at the daily returns of the Hot List, the Top 5 Gurus portfolio, and the Kenneth Fisher-, Motley Fool-, and Benjamin Graham-based portfolios, and how those daily returns compared to the S&P 500's daily return. On average, these five portfolios have returned 13.3% annualized since July 2003 -- while the S&P 500 has returned 4.5% annualized in what generally has been a pretty bad decade or so for stocks. Given that on average these portfolios have tripled the S&P's gain, what percentage of days would you guess that they'd outperformed the index? 60%? 70%? 80%? Here are the actual percentages:

Hot List Portfolio: 52.78%
Top 5 Gurus Portfolio: 51.62%
Graham-Based Portfolio: 52.33%
Motley Fool-Based Portfolio: 52.16%
Fisher-Based Portfolio: 52.08%
Average: 52.19%

I don't know about you, but I found those numbers extremely intriguing and quite surprising. I would've guessed that they would've been significantly higher, given the exceptional performance of the portfolios. Essentially, that means that in a typical month that had 23 trading days, one of those portfolios would fare better than the market on 12 days, and worse than the market on 11 days.

This data is a great example of why you shouldn't hyperfocus on your portfolio's day-to-day fluctuations. Portfolios with exceptional performance over the long term still have plenty of bad days. In fact, as you can see, they can have nearly as many bad days as they have good days.

What's more, the timing of the really good and really bad days can be key. In May of 2010, when the European debt crisis was heating up, the Hot List had a day where it underperformed the S&P by 8.79%. It followed that up with three more days in which it underperformed the index. But if you'd sold at that point, you'd have missed out on a 9.37% gain the next day, one of the portfolio's best days ever.

During the 2008 financial crisis, the potential for horrible timing decisions was extremely high. Starting on November 20, the Hot List had a string of five straight days where it underperformed the S&P. But if you ditched the portfolio during that run, you'd have missed out -- big-time. The day after that five-day losing streak, the portfolio rose 4.66% -- and the next day it had its biggest one-day gain ever, surging 20.05% in a single day.

Those aren't the only examples. Often after a few very bad days, stocks will then have a big bounce-back, as investors realize they've overreacted. That can be particularly true for value-focused portfolios like many of ours.

Bailing on the market after a few bad days can thus result in a double whammy for your portfolio -- you get hit by the bad days, jump out of stocks, and then don't get the benefit of the big gains on the bounce-back days. That's a problem that plagues many average investors, and it's part of the reason that so many underperform the broader market over the long haul.

I think data like this also validates our approach to selling. As you know, we rebalance our portfolios on a disciplined, unbending schedule, which for our main portfolios is every 28 days. (There are exceptions, like when a company appears to have acted fraudulently so we can't trust its fundamentals, or a holding hits a stop-loss target.) We do this because we know how tempting it is to react to short-term movements of a stock or the broader market. By keeping this quantitative, disciplined system in place, we ensure that we never let our own emotions -- which so often lead investors astray -- interfere with good, long-term investment approaches.

That systematic buying and selling is, I believe, one of the biggest reasons that the Hot List and the vast majority of our other guru-inspired portfolios have fared so well over the long haul. Sticking to that kind of disciplined approach is difficult, particularly at first, and particularly in today's world. In the past decade it has become exponentially easier to keep an eye on how your stocks or the broader market are performing -- forget day-to-day market updates; now you can get a minute to minute, or even second to second update on how every stock you own is doing. To be sure, it's good to stay relatively up-to-date on your holdings -- and you should definitely be aware of how the companies behind the shares you own are performing, business-wise. But monitoring how much those shares have risen or fallen every hour, every day, or even every week is, in my opinion, counterproductive. When your money's at stake, viewing inevitable short-term fluctuations so frequently can wreak havoc on your emotions, leading you to sell good stocks on short-term dips. Whether you are investing via the Hot List of some other approach, I'd thus recommend that you have some sort of rebalancing system in place for yourself, so that you don't make emotion-driven decisions that can eat away at your returns.

Remember, over the long term, minute to minute or second to second or day-to-day fluctuations don't mean nearly as much as people think they do. Great stocks of great companies have terrible days, and great portfolios filled with great stocks have terrible days. What matters are the fundamentals and financials of the companies in your portfolio. That's because, over the long-term, fundamentals and financials win out. Good companies with cheap shares will net you solid returns more often than not, and that's all it takes to do very well over the long haul. That point is critical to remember -- and easier to forget the more you hyperfocus on your portfolio's short-term fluctuations.
Editor-in-Chief: John Reese

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** Validea Capital Management is a separate investment advisory firm managed by Validea.com founder John Reese. Thre information above in not intended as personal investment advice and should not be interpreted as such.

The Fallen

As we rebalance the Validea Hot List, 6 stocks leave our portfolio. These include: Guess?, Inc. (GES), Rue21, Inc. (RUE), Oracle Corporation (ORCL), Jos. A. Bank Clothiers Inc (JOSB), Hibbett Sports, Inc. (HIBB) and Northrop Grumman Corporation (NOC).

The Keepers

4 stocks remain in the portfolio. They are: Ross Stores, Inc. (ROST), The Tjx Companies, Inc. (TJX), Usana Health Sciences, Inc. (USNA) and Main Street Capital Corporation (MAIN).

The Newbies

We are adding 6 stocks to the portfolio. These include: Western Digital Corp. (WDC), World Acceptance Corp. (WRLD), Questcor Pharmaceuticals, Inc. (QCOR), Lukoil (Adr) (LUKOY), Lear Corporation (LEA) and Starz (STRZA).

Portfolio Changes

Newcomers to the Validea Hot List

Lukoil OAO (LUKOY): Russia-based Lukoil ($57 billion market cap) is the world's largest privately owned oil and gas company based on proved oil reserves, and is responsible for about 17% of Russian crude oil production. Its products are sold in Russia and former USSR republics, as well as Europe, Asia, and the U.S.

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

Western Digital Corp. (WDC): This California-based firm is a leader in the hard drive and digital storage business. The 40-year-old company has a market cap of about $11.7 billion, and has raked in $15.6 billion in sales in the past year. It gets approval from my Peter Lynch- and Kenneth Fisher-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

World Acceptance Corp. (WRLD): Based in Greenville, S.C., World Acceptance ($1 billion market cap) specializes in small, short-term loans, and has close to 1,000 offices in the southern and central U.S., and Mexico. Its loans are generally under $3,000 and have durations of less than 24 months, and much of its business comes from repeat customers.

World Acceptance gets strong interest from my Peter Lynch- and Warren Buffett-based models. For more on its fundamentals, see the "Detailed Stock Analysis" section below.

Starz (STRZA): Formerly known as Liberty Media Corporation, Starz is a media and entertainment company whose pay-TV network includes the Starz, Encore, and Movieplex, Retroplex and Indieplex channels. The Colorado-based firm has a $2.2 billion market cap and has taken in about $2.5 billion in sales in the past year.

Starz gets strong interest from my Peter Lynch-based model, and high scores from a number of other strategies. For more about it, see the "Detailed Stock Analysis" section below.

Questcor Pharmaceuticals Inc. (QCOR): California-based Questcor's shares were crushed last September when it was revealed that Aetna would stop reimbursement for most uses of Questcor's main product, a gel used to treat infantile spasms, multiple sclerosis, neuromuscular conditions, and a kidney condition. But as is often the case when bad news hits, investors punished the stock too much, according to my models. The $1.6-billion-market-cap firm gets strong interest from my Peter Lynch- and Joel Greenblatt-based models, in large part because of its attractive valuations. To read more about it, scroll down to the "Detailed Stock Analysis" section below.

Lear Corporation (LEA): Michigan-based Lear supplies automotive seating and electrical power management systems. The $5.2-billion-market-cap firm has employees in 36 countries, and in the past year has taken in nearly $15 billion in sales.

Lear gets strong interest from my Peter Lynch- and James O'Shaughnessy-based models. For more on its fundamentals, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

USANA Health Sciences (USNA): USANA shares have surged since the firm last week reported fourth-quarter earnings of $1.27 per share on revenue of $168.5 million, beating analyst expectations of $1.21 per share and $165.6 million, the Motley Fool reported. USANA also set guidance for the upcoming year of $700 million to $720 million in revenue, and adjusted EPS of $5.10 to $5.25, both of which were quite favorable given analysts' projections of $4.84 and $701.6 million. As of late morning on Feb. 14, shares were up about 10.5% since the Feb. 5 earnings announcement.

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will take a closer look at my strategies and investment approach. If you have any questions, please feel free to contact us at hotlist@validea.com.

Current Portfolio

Detailed Stock Analysis

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

MAIN   |   LUKOY   |   USNA   |   STRZA   |   LEA   |   WRLD   |   WDC   |   QCOR   |   ROST   |   TJX   |  

Main Street Capital Corporation is a United States-based principal investment firm that primarily provides long-term debt and equity capital to lower middle market companies. The Firm targets investments associated with ownership transitions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives for later stage businesses. In addition to providing companies with necessary capital, Main Street provides management with expertise in corporate finance, operations and growth strategy implementation.

NK Lukoil OAO (Neftyanaya Kompaniya LUKOIL OAO or NK LUKOIL OJSC) is a Russia-based integrated oil and gas company. The Company is engaged in the business of oil exploration, production, refining, marketing and distribution. It is an owner of refineries, gas processing, petrochemical plants and gas stations network located in Russia, Eastern and Western Europe. The Company's petroleum products are sold in the Russian Federation, the Commonwealth of Independent States (CIS) countries, Eastern and Western Europe, Asia and the United States. NK Lukoil OAO operates through numerous subsidiaries and affiliated companies. As of December 31, 2011, the Company's major shareholder was ING Bank (Eurasia) ZAO with a stake of 75.93%.

USANA Health Sciences, Inc. develops and manufactures science-based nutritional and personal care products. The Company has operations in 15 markets worldwide, where it distributes and sells its products by way of direct selling. The Company reports operations in two geographic regions: North America and Asia Pacific, which is further divided into three sub-regions; Southeast Asia/Pacific, Greater China, and North Asia. North America includes the United States, Canada, Mexico, and direct sales from the United States to the United Kingdom and the Netherlands. Southeast Asia/Pacific includes Australia, New Zealand, Singapore, Malaysia, and the Philippines; Greater China includes Hong Kong, Taiwan and China; and North Asia includes Japan and South Korea. The Company's customer base consists of two types of customers: Associates and Preferred Customers. As of December 31, 2011, the Company had 222,000 active Associates and 64,000 active Preferred Customers worldwide.

Starz, formerly Liberty Media Corporation, is an integrated global media and entertainment company with operating units that provide subscription video programming on domestic United States pay television channels (Starz Channels), global content distribution (Starz Distribution) and animated television and movie production (Starz Animation). As of January 14, 2013, its network included Starz, Encore, and Movieplex, Retroplex and Indieplex. Its businesses included Anchor Bay Entertainment, Starz Worldwide Distribution, and Starz Digital Media. Starz Animation produces animated television (TV) and movie content for studios and networks. Starz Distribution develops, produces and acquires entertainment content, distributing it to consumers globally on digital versatile disk (DVD). On January 11, 2013, Liberty Media Corporation (Liberty) and Starz announced the completion of the spin-off of Liberty from Starz.

Lear Corporation is a tier 1 supplier to the global automotive industry. The Company supplies its products to automotive manufacturers with automotive seat systems and related components, as well as electrical distribution systems and related components. The Company has two segments: seating and electrical power management systems (EPMS). The seating segment includes seat systems and related components, such as seat frames, recliner mechanisms, seat tracks, seat trim covers, headrests and seat foam. The EPMS segment includes electrical distribution systems for traditional powertrain vehicles, as well as for hybrid and electric vehicles. As of December 31, 2011, it had 20 joint ventures located throughout Asia, as well as five in North America, two in Europe and Africa and one with operations in all three regions.

World Acceptance Corporation operates a small-loan consumer finance business in 12 states and Mexico. The Company is engaged in the small-loan consumer finance business, offering short-term small loans, medium-term larger loans, related credit insurance and ancillary products and services to individuals. As of March 31, 2012, the Company offered standardized installment loans through 1,137 offices in South Carolina, Georgia, Texas, Oklahoma, Louisiana, Tennessee, Illinois, Missouri, New Mexico, Kentucky, Alabama, Wisconsin, and Mexico. The Company serves individuals with limited access to consumer credit from banks, credit unions, other consumer finance businesses and credit card lenders. In the United States offices, the Company also offers income tax return preparation services to its customers and others.

Western Digital Corporation (WD) is a provider of solutions for the collection, storage, management, protection and use of digital content, including audio and video. Its principal products are hard drives, which are devices that use one or more rotating magnetic disks (magnetic media) to store and allow access to data. Its hard drives are used in desktop and notebook computers, corporate and cloud computing data centers, home entertainment equipment and stand-alone consumer storage devices. In addition to hard drives, its other products include solid-state drives and home entertainment and networking products. Effective March 8, 2012, it acquired Viviti Technologies Ltd. In May 2012, the Company completed the divestiture of certain 3.5-inch hard drive assets to Toshiba Corporation. As part of its deal with Toshiba, WD also completed its purchase of Toshiba Storage Device (Thailand) Company Limited (TSDT), which manufactured hard drives.

Questcor Pharmaceuticals, Inc. (Questcor) is a biopharmaceutical company. The Company's primary product is H.P. Acthar Gel (repository corticotropin injection) (Acthar), an injectable drug that is approved by the United States Food and Drug Administration, for the treatment of 19 indications. As of December 31, 2011, H.P. Acthar Gel was approved for the treatment of acute exacerbations of multiple sclerosis in adults, and as monotherapy for the treatment of infantile spasms in infants and children under two years of age. It is also indicated to induce a diuresis or a remission of proteinuria in the nephrotic syndrome without uremia of the idiopathic type or that due to lupus erythematosus, as well as indicated for the treatment of a number of other diseases and disorders. Its other product is Doral (quazepam), which is indicated for the treatment of insomnia.

Ross Stores, Inc., along with its subsidiaries, operates two brands of off-price retail apparel and home fashion stores. As of January 28, 2012, the Company operated a total of 1,125 stores, of which 1,037 were Ross Dress for Less (Ross) locations in 29 states, the District of Columbia, and Guam, and 88 were dd's DISCOUNTS stores in seven states: 48 in California, 19 in Texas, 12 in Florida, four in Arizona, two in Georgia, two in Nevada, and one in Maryland. Ross focuses on customers primarily from middle income households, while dd's DISCOUNTS focuses on customers from more moderate income households. During the fiscal year ended January 28, 2012 (fiscal 2012), it opened 59 new Ross stores and closed ten existing stores. During fiscal 2011, it opened 21 new dd's DISCOUNTS stores. The average approximate dd's DISCOUNTS store size is 23,900 square feet. In April 2011, it purchased a 449,000 square foot warehouse for packaway storage in Riverside, California.

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

Watch List

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


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

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.