|Executive Summary | Portfolio | Guru Analysis | Watch List|
|Executive Summary||February 15, 2013|
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%
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.
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).
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).
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).
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 email@example.com.
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