Economy & Markets

There has been little to calm the market's jitters over trade tensions and economic growth around the world, both of which have weighed on stocks in recent weeks. Traders have also been very busy trying to parse the words of Federal Reserve Chairman Jerome Powell on interest rates and whether the Fed will be aggressive or back off from earlier plans for gradual hikes through next year. Analysts attempting to model 2019 earnings have had difficulty without clarity on the effects of tariffs, taxes and interest rates on the ability for companies to generate earnings growth. Already, expectations are that earnings will climb next year, but the rate of growth will slow as the effect of tax breaks wears off. The S&P 500 is trading at a multiple of around 18, led by health care, consumer discretionary and information technology. Laggards include communications, materials and energy. The Dow Jones Industrial Average trades at a multiple of 16.4.

Some numbers to watch:

1. The Federal Reserve warned that ongoing trade tensions, geopolitical risks and elevated asset prices could lead to an adverse market shock as investors take risk off the table.

2. Consumer spending rose 0.6% last month, more than the 0.4% expected, as households spent more on prescription medicine and utilities. But the University of Michigan survey showed sentiment dipped to 97.5 from 98.6.

3. An IHS Markit survey showed 4 in 10 companies plan to raise prices to offset production cost increases. American consumers will pay more because of tariffs, but jobs won't be coming home.

4. Global wage growth fell to its lowest in almost a decade last year, with the U.K. seeing weaker wage growth than any other advanced G-20 nations.

5. Home values rose 5.5 percent annually in September, but continued gains have now shrunk to the lowest level since January 2017, according to the S&P CoreLogic Case-Shiller U.S. National Home Price Index.

Recommended Reading

Michael Batnick outlined common investment mistakes people make, even the investing legends, in a recent article in AAII Journal. Among the biggest mistakes are expecting the future to look like the recent past, believing the price paid for a security should be factored into how the investment is viewed going forward, and looking at the stock instead of the underlying company. People hate to admit they were wrong, especially when it comes to investing. But that kind of thinking can interfere with achieving long-term goals. Read more here and look below for links to articles and blog posts you might have missed.

Invest Now: Bloomberg recently interviewed some star investors about where they would put $10,000 now. BlackRock's Russ Koesterich pointed to Asia stocks. Ian Harnett of Absolute Strategy Research said he would go long U.S. Treasurys. Jim Paulsen of Leuthold said it's time to get defensive on stocks. Read more

Tech Misperception: Bernstein advisor Richard Bernstein says bonds are as risky as tech stocks were in 2000 and that investors have misperceptions about emerging markets and tech. Emerging markets are growth investments, while tech stocks can suffer long periods of underperformance. Read more

Billionaire Touch: Forbes recently ran down the investing approaches of some prominent billionaires. Sequoia Capital former partner Mark, an early backer of Yahoo, Google and LinkedIn, has been diversifying into energy, healthcare and real estate. Yarbrough Capital's John Yarbrough is investing in short-term bonds and tech stocks. Read more

Bear Scare: Investors can protect themselves from the bear market by recognizing what kind of bear it is, according to an article in Advisor Perspectives. A traditional bear market can force investors to make emotional and counterproductive decisions. A "bear cub" market is more fleeting. Read more

Manager Manifesto: Mohnish Pabrai ran through the 10 commandments of money management in a recent presentation at Boston College. This first three: Don't take fees off the top (something Warren Buffett would agree with), make your own investment decisions, and be humble. You invest in P/E's of 1, good things happen to you." He cites the example of his investment in Fiat. Read more

Emerging Risk: The emerging markets sell-off is triggered by rising interest rates and trade tensions. Asset managers have also become lenders to these companies, according to the WSJ. "That is important," it says, "because it spreads the risks across lenders and funds." Read more

Quantamental Rise: Quants and fundamental stock pickers are putting their heads together to produce better returns for investors. The verdict is still out on whether it's working, but the blend of these two styles may soon make the term "quantamental" common among investors, Marketwatch reports. Read more

IPO Trend: Citing data compiled by University of Florida finance professor Jay Ritter, the WSJ reports that about 83% of U.S. listed IPOs in the first three quarters of 2018 involved companies that "lost money in the 12 months leading up to their debut," which the professor says is the highest percentage on record. Read more

Retirement Warning: People with less than $2 million saved will likely not be able to retire at age 65 and maintain their preretirement lifestyle, according to a recent story in Financial Advisor magazine. They will have to work longer, says Steve Vernon, or reduce their standards of living. Read more

EPS Trail: Bloomberg reports that the number of S&P 500 companies saying profits will trail analyst estimates outnumbered those saying they'll beat them by a ratio of 8-to-1 in the third quarter. Companies are "making room for the quarterly ritual in which they beat every forecast by a penny." Read more

High Price: U.S. stocks are trading at their highest premiums to international stocks in years, the WSJ notes. That could mean strong confidence in the U.S. economy but it also means U.S. stocks are richly valued. Read more

News on Hot List Stocks

Maximus reported fiscal year 2018 revenue of $2.39 billion and profit of $3.35 a share. Earlier this month it completed the $400 million acquisition of U.S. Federal civilian citizen engagement centers.

Universal Insurance Holdings announced a quarterly cash dividend of 29 cents per share payable on Dec. 4 for investors as of Nov. 27. The payout includes a special 13 per share cash dividend.

Since our last newsletter, the S&P 500 returned 0.3%, while the Hot List returned 1.1%. So far in 2015, the portfolio has returned -16.9% vs. 2.4% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 202.3% vs. the S&P's 173.7% gain.

When Hypothetical Becomes Real

Do you have what it takes to become a factor investor? There are a few things you may not have considered.

It's a lot tougher than it looks on paper, for starters. Deciding to dive in is not a quick process, of course. It takes research and an examination of long-term historical results. Once you have developed a conviction, you expect to see similar results in the future but you are prepared to accept that your strategy won't always work. It's not going to be foolproof through every market turn. But you believe in the process and are willing to deal with an experience that won't be just a straight line higher.

That's all on paper. Things change when you have actual money on the line.

That's because once you plunk down your cash, human emotion and doubt starts to creep in. Factor investing isn't a six-month strategy. It requires persistence for years and decades. But still there's the temptation to check your account balance as the markets go up and, especially, down. Doubts start to overwhelm you and wear on your resolve. You start to second-guess things, and that's when the real danger sets it. You risk abandoning your strategy after only a short while.

But that ruins your objective in the first place. It is the ability to make it through the short and the long-term periods of underperformance where the real benefit kicks in. If you abandon your strategy at the first sign if turmoil, you miss out on the good periods when they do come.

Value investors have waited for the last decade for that day to come, and they are still waiting. This factor, made popular by legends like Benjamin Graham and Warren Buffett, has been on the outs as high-growth tech stocks have gotten all the attention from investors. There's a lot of evidence that value investing wins out over growth over decades, but that's not going to convince a novice investor that it's the right approach without a serious sales pitch. Fortunately, value disciples have Buffett as their pitchman. Rather than ditch the market he has quietly bought up stocks in the retail, transportation, financial and consumer products sectors over the years, using the downturns to buy up beaten down stocks.

No factor outperforms every year, every three-year period, every five-year period, or even every decade. In order to achieve the long-term results, like Buffett, you have to be able to sit through these periods, no matter how difficult they get.

There are some things you can do up front that will help set expectations.

1 - Only the Strongest Levels of Conviction Will Survive

There is no room for uncertainty. Success at factor investing requires complete commitment. If you aren't sure whether value is the right strategy for you, don't do it until you are. That's because any weakness can because an excuse for bailing in tough times. Even those with somewhat strong levels of conviction could be tempted to cut and run after a prolonged period of difficulty. Only those with truly iron-clad commitment will be able to stay the course. The alternative to factor investing is indexing, and there's certainly no shame in that, either.

2 - Understand What Long-Term Means

When it comes to factor investing, three years is just the beginning. But that's exactly the time frame many investors use to judge the track records of money managers. It is, in fact, the worst time frame to use. The span of time is just long enough for a manager to do well or poorly and then revert to the mean. The fund manager you dump for poor performance after three years is statistically more likely to outperform the new one you hire in his place for the next three years. Yet even professionals like pensions fall prey to this, firing managers after three years and hiring new ones as they chase performance.

The benefit of longer-term horizons is they eliminate a lot of the short-term noise and become better guideposts. But as we know with value, factor strategies can suffer for significant periods of time.

Given that all factors have had historical periods of 10 years where they have underperformed, the true period it takes to judge a factor-based strategy is probably at least 20 years. That is a major problem for investors who tend to want to evaluate a strategy based on short-term results.

And there is a strong argument 20 years isn't even enough.

Corey Hoffstein of Newfound Research looked at the major investing factors and tried to determine the length of time they would need to stop working. He found that the period of time it would take to dismiss the major factors ranged from 67 years for value (price/book) to over 300 years for momentum. These are far from exact numbers, but they do show that the amount of time it would take to say definitively that a factor no longer works is longer than our investing lifetimes.

3 - Focus on the Bad Going In

It's easy to feel good about investing when everything is going your way. Who doesn't love 20% annual gains? Tech investors probably felt really good about their strategy until recently.

The good times aren't going to make or break you.

It is the bad years, especially the really bad ones, that will ultimately determine your success. When you look at an investment strategy, it is a good idea to first look at the worst that history had to offer and to consider whether you could have made it through it.

As an example, if I was looking to follow a value strategy, I would look at the late 90s. Using data from Ken French's website, a portfolio holding the cheapest 10% of stocks using price/book would have returned 45% from the beginning of 1998 to the end of 1999. That sounds really good until you consider that the most expensive 10% returned double that. So to follow a value strategy during that period, you would have had to maintain discipline while watching other investors make twice as much as you buying high flying technology stocks. It's easy to say now that you could have done that since we all know those technology stocks eventually fell apart. It was far harder to do then. By looking at a worst-case scenario from history going in, you give yourself a better chance to endure it when it occurs.

Simple, But Not Easy

Even with the best preparation for a factor-based investment strategy, you will still experience a test of will and endurance. And you won't really know how you feel about that until you're in the thick of it. At Validea, we have developed a systematic way of investing using factor strategies to try to eliminate as much of this human emotion as possible. By focusing on these steps, and taking a systematic and automatic approach, you should have some comfort that you will make it through even when times get tough. Given how difficult factor investing can be at times, you will need all the help you can get.


Portfolio Holdings
Ticker Date Added Return
UVE 8/24/2018 -3.3%
AVAV 9/21/2018 -14.4%
CACC 3/9/2018 20.9%
ESRX 11/16/2018 3.7%
REPYY 10/19/2018 -6.9%
UNH 10/19/2018 6.5%
DHI 11/16/2018 7.4%
ULTA 9/21/2018 7.0%
MSGN 11/16/2018 5.7%
MMS 11/16/2018 5.7%


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

UVE   |   AVAV   |   CACC   |   ESRX   |   REPYY   |   UNH   |   DHI   |   ULTA   |   MSGN   |   MMS   |  

UNIVERSAL INSURANCE HOLDINGS, INC.

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

Universal Insurance Holdings, Inc. (UVE) is a private personal residential homeowners insurance company in Florida. The Company performs substantially all aspects of insurance underwriting, policy issuance, general administration, and claims processing and settlement internally. The Company's subsidiaries include Universal Property & Casualty Insurance Company (UPCIC) and American Platinum Property and Casualty Insurance Company (APPCIC). UPCIC writes homeowners insurance policies in states, including Alabama, Delaware, Florida, Georgia, Hawaii, Indiana, Maryland, Massachusetts, Michigan, Minnesota, North Carolina, Pennsylvania, South Carolina and Virginia. APPCIC writes homeowners and commercial residential insurance policies in Florida. The Company has developed a suite of applications that provide underwriting, policy and claim administration services, including billing, policy maintenance, inspections, refunds, commissions and data analysis.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (9.44) relative to the growth rate (22.50%), 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 UVE (0.42) is very favorable.


SALES AND P/E RATIO: NEUTRAL

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth rate high enough to support a P/E above this threshold. UVE, whose sales are $808.8 million, is not considered large enough to apply the P/E ratio analysis. However, an investor can analyze the P/E ratio relative to the EPS growth rate.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for UVE is 22.5%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is considered very good.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

UVE 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. UVE's Equity/Assets ratio (31.00%) is extremely healthy and above the minimum 5% this methodology looks for, thus passing the criterion.


RETURN ON ASSETS: PASS

This methodology uses Return on Assets as a way to measure a financial intermediary's profitability. UVE's ROA (9.26%) 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 UVE (5.42%) 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 UVE (12.76%) 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.

AEROVIRONMENT, INC.

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

AeroVironment, Inc. designs, develops, produces, supports and operates a portfolio of products and services for government agencies, businesses and consumers. The Company operates through the Unmanned Aircraft Systems (UAS) segment, which focuses primarily on the design, development, production, support and operation of UAS and tactical missile systems that provide situational awareness, multi-band communications, force protection and other mission effects. The Company supplies UAS, tactical missile systems and related services primarily to organizations within the United States Department of Defense (DoD). The Company's small UAS products include Raven, Wasp AE, Puma AE and Shrike. The Company also offers the Qube, an UAS for law enforcement, search and rescue and fire department personnel.


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. AVAV's profit margin of 17.17% 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. AVAV, with a relative strength of 96, satisfies this test.


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

Companies must demonstrate both revenue and net income growth of at least 25% as compared to the prior year. These growth rates give you the dynamic companies that you are looking for. These rates for AVAV (-547.37% for EPS, and 127.12% for Sales) are not good enough to pass.


INSIDER HOLDINGS: PASS

AVAV's insiders should own at least 10% (they own 10.61% ) of the company's outstanding shares which is the minimum required. A high percentage typically indicates that the insiders are confident that the company will do well.


CASH FLOW FROM OPERATIONS: PASS

A positive cash flow is typically used for internal expansion, acquisitions, dividend payments, etc. A company that generates rather than consumes cash is in much better shape to fund such activities on their own, rather than needing to borrow funds to do so. AVAV's free cash flow of $2.50 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

AVAV's profit margin has been consistent or even increasing over the past three years (Current year: 7.40%, Last year: 5.45%, Two years ago: 3.84%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise.


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 AVAV's case.


CASH AND CASH EQUIVALENTS: PASS

AVAV's level of cash $257.2 million passes this criteria. If a company is a cash generator, like AVAV, it has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash.


INVENTORY TO SALES: PASS

This methodology strongly believes that companies, especially small ones, should have tight control over inventory. It's a warning sign if a company's inventory relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Inventory to Sales for AVAV was 26.24% last year, while for this year it is 13.81%. Since the inventory to sales is decreasing by -12.44% the stock passes this criterion.


ACCOUNT RECEIVABLE TO SALES: PASS

This methodology wants to make sure that a company's accounts receivable do not get significantly out of line with sales. It's a warning sign if a company's accounts receivable relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Accounts Receivable to Sales for AVAV was 38.65% last year, while for this year it is 27.18%. Since the AR to sales is decreasing by -11.46% the stock passes this criterion.


LONG TERM DEBT/EQUITY RATIO: PASS

AVAV's trailing twelve-month Debt/Equity ratio (0.00%) is at a great level according to this methodology because the superior companies that you are looking for don't need to borrow money in order to grow.


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

The "Fool Ratio" is an extremely important aspect of this analysis. The methodology says consider holding the shares when the company's Fool Ratio is greater than 0.65 (AVAV's is 0.92), but initial purchases in this range are unfavorable.

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

AVERAGE SHARES OUTSTANDING: PASS

AVAV has not been significantly increasing the number of shares outstanding within recent years which is a good sign. AVAV currently has 24.0 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. AVAV's sales of $305.3 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". AVAV passes the sales test.


DAILY DOLLAR VOLUME: FAIL

AVAV does not pass the Daily Dollar Volume (DDV of $34.8 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. AVAV with a price of $91.68 passes the price test, even though it doesn't fall in the preferred range. The price should be above $7 in order to eliminate penny stocks and below $20 since most stocks in this price range are undiscovered by the institutions.


INCOME TAX PERCENTAGE: FAIL

AVAV's income tax paid expressed as a percentage of pretax income either this year (20.05%) or last year (19.84%) is below 20% which is cause for concern. Because the tax rate is below 20% this could mean that the earnings that were reported are unrealistically inflated due to the lower level of income tax paid. However, we have utilized a sophisticated formula so that the appropriate figures reflect a 'normal' tax rate (35%).

CREDIT ACCEPTANCE CORP.

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

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


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. CACC's profit margin of 56.82% passes this test.


RELATIVE STRENGTH: FAIL

The investor must look at the relative strength of the company in question. Companies whose relative strength is 90 or above (that is, the company outperforms 90% or more of the market for the past year), are considered attractive. Companies whose price has been rising much quicker than the market tend to keep rising. Although CACC's relative strength of 87 is below the acceptable level, yet it is very close. Keep an eye on the stock as it could move into the acceptable range.


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

Companies must demonstrate both revenue and net income growth of at least 25% as compared to the prior year. These growth rates give you the dynamic companies that you are looking for. These rates for CACC (49.33% for EPS, and 16.94% for Sales) are not good enough to pass.


INSIDER HOLDINGS: FAIL

CACC's insiders should own at least 10% (they own 4.64%) of the company's outstanding shares. This does not satisfy the minimum requirement, and companies that do not pass this criteria are less attractive.


CASH FLOW FROM OPERATIONS: PASS

A positive cash flow is typically used for internal expansion, acquisitions, dividend payments, etc. A company that generates rather than consumes cash is in much better shape to fund such activities on their own, rather than needing to borrow funds to do so. CACC's free cash flow of $28.51 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

CACC's profit margin has been consistent or even increasing over the past three years (Current year: 42.36%, Last year: 34.34%, Two years ago: 36.31%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise.


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 CACC's case.


CASH AND CASH EQUIVALENTS: FAIL

CACC does not have a sufficiently large amount of cash, $8.20 million, on hand relative to its size. Although this criteria does not apply to companies of this size, we defined anything greater than $500 million in cash as having 'a lot of cash' to allow analysis of these companies. CACC will have more of a difficult time paying off debt (if it has any) or acquiring other companies than a company that passes this criterion.


ACCOUNT RECEIVABLE TO SALES: PASS

This methodology wants to make sure that a company's accounts receivable do not get significantly out of line with sales. It's a warning sign if a company's accounts receivable relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Accounts Receivable to Sales for CACC was 0.24% last year, while for this year it is 0.20%. Since the AR to sales has been flat, CACC passes this test.


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

The "Fool Ratio" is an extremely important aspect of this analysis. If the company has attractive fundamentals and its Fool Ratio is 0.5 or less (CACC's is 0.38), the shares are looked upon favorably. These high quality companies can often wind up as the biggest winners. CACC passes this test.

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

AVERAGE SHARES OUTSTANDING: PASS

CACC has not been significantly increasing the number of shares outstanding within recent years which is a good sign. CACC currently has 19.0 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: FAIL

Companies with sales less than $500 million should be chosen. It is among these small-cap stocks that investors can find "an uncut gem", ones that institutions won't be able to buy yet. CACC's sales of $1,230.3 million based on trailing 12 month sales, are too high and would therefore fail the test. It is companies with $500 million or less in sales that are most likely to double or triple in size in the next few years.


DAILY DOLLAR VOLUME: FAIL

CACC does not pass the Daily Dollar Volume (DDV of $36.0 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. CACC with a price of $410.40 passes the price test, even though it doesn't fall in the preferred range. The price should be above $7 in order to eliminate penny stocks and below $20 since most stocks in this price range are undiscovered by the institutions.


INCOME TAX PERCENTAGE: FAIL

CACC's income tax paid expressed as a percentage of pretax income either this year (2.36%) or last year (37.35%) is below 20% which is cause for concern. Because the tax rate is below 20% this could mean that the earnings that were reported are unrealistically inflated due to the lower level of income tax paid. However, we have utilized a sophisticated formula so that the appropriate figures reflect a 'normal' tax rate (35%).

EXPRESS SCRIPTS HOLDING CO

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

Express Scripts Holding Company is a pharmacy benefit management (PBM) company. The Company is engaged in providing healthcare management and administration services to its clients, including managed care organizations, health insurers, third-party administrators, employers, union-sponsored benefit plans, workers' compensation plans and government health programs. The Company operates through two segments: PBM and Other Business Operations. The PBM segment includes its integrated PBM operations and specialty pharmacy operations. Its Other Business Operations segment includes its subsidiary, United BioSource Corporation (UBC), and its specialty distribution operations. Its integrated PBM services include clinical solutions, Express Scripts SafeGuardRx, specialized pharmacy care, home delivery pharmacy services, specialty pharmacy services, retail network pharmacy administration, benefit design consultation, drug utilization review and drug formulary management.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (9.15) relative to the growth rate (47.20%), 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 ESRX (0.19) 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. ESRX, whose sales are $101,353.2 million, needs to have a P/E below 40 to pass this criterion. ESRX's P/E of (9.15) 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 ESRX is 47.2%, 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 ESRX (72.91%) to be mediocre. If the Debt/Equity ratio is this high, the other ratios and financial statistics for ESRX should be good enough to compensate.


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 ESRX (8.61%) 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 ESRX (-18.55%) 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.

REPSOL SA (ADR)

Strategy: Growth Investor
Based on: Martin Zweig

Repsol, S.A. (Repsol) is an integrated energy company. The Company's segments include Upstream, Downstream, and Corporation and others. The Upstream segment carries out oil and natural gas exploration and production activities, and manages its project portfolio. The Downstream segment includes covers the supply and trading of crude oil and other products; oil refining and marketing of oil products, and the production and marketing of chemicals. It owns and operates five refineries in Spain (Cartagena, A Coruna, Bilbao, Puertollano and Tarragona) with a combined distillation capacity of approximately 900 thousand barrels of oil per day. The Company operates La Pampilla refinery in Peru, which has an installed capacity of approximately 120 thousand barrels of oil per day. Its Chemicals division produces and commercializes a range of products, and its activities range from basic petrochemicals to derivatives.


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. REPYY's P/E is 10.54, based on trailing 12 month earnings, while the current market PE is 16.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: FAIL

Revenue Growth must not be substantially less than earnings growth. For earnings to continue to grow over time they must be supported by a comparable or better sales growth rate and not just by cost cutting or other non-sales measures. REPYY's revenue growth is -3.55%, while it's earnings growth rate is 19.96%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, REPYY fails this criterion.


SALES GROWTH RATE: PASS

Another important issue regarding sales growth is that the rate of quarterly sales growth is rising. To evaluate this, the change from this quarter last year to the present quarter (32.2%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (22.6%) of the current year. Sales growth for the prior must be greater than the latter. For REPYY 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. REPYY's EPS ($0.44) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. REPYY's EPS for this quarter last year ($0.34) 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. REPYY's growth rate of 29.41% 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 REPYY is 9.98%. This should be less than the growth rates for the 3 previous quarters which are 72.73%, -22.45% and 90.91%. REPYY 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, 26.88%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 29.41%, (versus the same quarter one year ago) then the stock passes.


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

The EPS growth rate for the current quarter, 29.41% must be greater than or equal to the historical growth which is 19.96%. REPYY would therefore pass this test.


EARNINGS PERSISTENCE: FAIL

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. REPYY, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.63, 0.72, -1.01, 1.01, and 1.49, fails this test.


LONG-TERM EPS GROWTH: PASS

One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. REPYY's long-term growth rate of 19.96%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes this test.


TOTAL DEBT/EQUITY RATIO: PASS

A final criterion is that a company must not have a high level of debt. A high level of total debt, due to high interest expenses, can have a very negative effect on earnings if business moderately turns down. If a company does have a high level, an investor may want to avoid this stock altogether. REPYY's Debt/Equity (35.72%) is not considered high relative to its industry (55.80%) and passes this test.

UNITEDHEALTH GROUP INC

Strategy: Growth Investor
Based on: Martin Zweig

UnitedHealth Group Incorporated is a health and well-being company. The Company operates through four segments: UnitedHealthcare, OptumHealth, OptumInsight and OptumRx. It conducts its operations through two business platforms: health benefits operating under UnitedHealthcare and health services operating under Optum. UnitedHealthcare provides healthcare benefits to an array of customers and markets, and includes UnitedHealthcare Employer & Individual, UnitedHealthcare Medicare & Retirement, UnitedHealthcare Community & State, and UnitedHealthcare Global businesses. Optum is a health services business serving the healthcare marketplace, including payers, care providers, employers, governments, life sciences companies and consumers, through its OptumHealth, OptumInsight and OptumRx businesses. OptumInsight provides services, technology and healthcare solutions to participants in the healthcare industry. OptumRx provides retail network contracting, purchasing and clinical solutions.


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. UNH's P/E is 24.50, based on trailing 12 month earnings, while the current market PE is 16.00. 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. UNH's revenue growth is 13.75%, while it's earnings growth rate is 15.15%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, UNH 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 (12.4%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (12.1%) of the current year. Sales growth for the prior must be greater than the latter. For UNH 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. UNH's EPS ($3.24) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. UNH's EPS for this quarter last year ($2.51) 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. UNH's growth rate of 29.08% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: PASS

Compare the earnings growth rate of the previous three quarters with long-term EPS growth rate. Earnings growth in the previous 3 quarters should be at least half of the long-term EPS growth rate. Half of the long-term EPS growth rate for UNH is 7.58%. This should be less than the growth rates for the 3 previous quarters, which are 40.23%, 28.70%, and 28.45%. UNH passes this test, which means that it has good, reasonably steady earnings.


This strategy looks at the rate which earnings grow and evaluates this rate of growth from different angles. The 4 tests immediately following are detailed below.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN PRIOR 3 QUARTERS: FAIL

If the growth rate of the prior three quarter's earnings, 31.80%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 29.08%, (versus the same quarter one year ago) then the stock fails, with one exception: if the growth rate in earnings between the current quarter and the same quarter one year ago is greater than 30%, then the stock would pass. The growth rate over this period for UNH is 29.1%, and it would therefore fail this test.


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

The EPS growth rate for the current quarter, 29.08% must be greater than or equal to the historical growth which is 15.15%. UNH would therefore pass this test.


EARNINGS PERSISTENCE: PASS

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. UNH, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 5.50, 5.70, 6.01, 7.25 and 9.50, 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. UNH's long-term growth rate of 15.15%, 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 UNH, this criterion has not been met (insider sell transactions are 545, while insiders buying number 334). 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.

D. R. HORTON INC

Strategy: Growth Investor
Based on: Martin Zweig

D.R. Horton, Inc. is a homebuilding company. The Company has operations in 81 markets in 27 states across the United States. The Company's segments include its 44 homebuilding divisions, its financial services operations and its other business activities. In the homebuilding segment, the Company builds and sells single-family detached homes and attached homes, such as town homes, duplexes, triplexes and condominiums. The Company's 44 homebuilding divisions are aggregated into six segments: East Region, South Central Region, Midwest Region, West Region, Southwest Region and Southeast Region. In the financial services segment, the Company sells mortgages and collects fees for title insurance agency and closing services. The Company has subsidiaries that conduct insurance-related operations; construct and own income-producing rental properties; own non-residential real estate, including ranch land and improvements, and own and operate oil and gas-related assets.


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. DHI's P/E is 9.13, based on trailing 12 month earnings, while the current market PE is 16.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: FAIL

Revenue Growth must not be substantially less than earnings growth. For earnings to continue to grow over time they must be supported by a comparable or better sales growth rate and not just by cost cutting or other non-sales measures. DHI's revenue growth is 17.87%, while it's earnings growth rate is 27.24%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, DHI fails this criterion.


SALES GROWTH RATE: FAIL

Another important issue regarding sales growth is that the rate of quarterly sales growth is rising. To evaluate this, the change from this quarter last year to the present quarter (8.3%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (17.4%) of the current year. Sales growth for the prior must be greater than the latter. For DHI this criterion has not been met and fails this test.


The earnings numbers of a company should be examined from various different angles. Three of these angles are stability in the trend of earnings, earnings persistence, and earnings acceleration. To evaluate stability, the stock has to pass the following four criteria.


CURRENT QUARTER EARNINGS: PASS

The first of these criteria is that the current EPS be positive. DHI's EPS ($1.22) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. DHI's EPS for this quarter last year ($0.82) 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. DHI's growth rate of 48.78% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: PASS

Compare the earnings growth rate of the previous three quarters with long-term EPS growth rate. Earnings growth in the previous 3 quarters should be at least half of the long-term EPS growth rate. Half of the long-term EPS growth rate for DHI is 13.62%. This should be less than the growth rates for the 3 previous quarters, which are 41.82%, 51.67%, and 55.26%. DHI passes this test, which means that it has good, reasonably steady earnings.


This strategy looks at the rate which earnings grow and evaluates this rate of growth from different angles. The 4 tests immediately following are detailed below.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN PRIOR 3 QUARTERS: PASS

If the growth rate of the prior three quarter's earnings, 50.26%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 48.78%, (versus the same quarter one year ago) then the stock fails, with one exception: if the growth rate in earnings between the current quarter and the same quarter one year ago is greater than 30%, then the stock would pass. The growth rate over this period for DHI is 48.8%, and it would therefore pass this test.


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

The EPS growth rate for the current quarter, 48.78% must be greater than or equal to the historical growth which is 27.24%. DHI would therefore pass this test.


EARNINGS PERSISTENCE: PASS

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. DHI, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 1.46, 2.03, 2.36, 2.74 and 4.09, 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. DHI's long-term growth rate of 27.24%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes this test.


TOTAL DEBT/EQUITY RATIO: PASS

A final criterion is that a company must not have a high level of debt. A high level of total debt, due to high interest expenses, can have a very negative effect on earnings if business moderately turns down. If a company does have a high level, an investor may want to avoid this stock altogether. DHI's Debt/Equity (35.66%) is not considered high relative to its industry (47.46%) and passes this test.


INSIDER TRANSACTIONS: PASS

A factor that adds to a stock's attractiveness is if insider buy transactions number 3 or more, while insider sell transactions are zero. Zweig calls this an insider buy signal. For DHI, this criterion has not been met (insider sell transactions are 133, while insiders buying number 80). 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.

ULTA BEAUTY INC

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

Ulta Beauty, Inc. is a holding company for the Ulta Beauty group of companies. The Company is a beauty retailer. The Company offers cosmetics, fragrance, skin, hair care products and salon services. The Company offers approximately 20,000 products from over 500 beauty brands across all categories, including the Company's own private label. The Company also offers a full-service salon in every store featuring hair, skin and brow services. The Company operates approximately 970 retail stores across over 48 states and the District of Columbia and also distributes its products through its Website, which includes a collection of tips, tutorials and social content. The Company offers makeup products, such as foundation, face powder, concealer, color correcting, face primer, blush, bronzer, contouring, highlighter, setting spray, shampoos, conditioners, hair styling products, hair styling tools and perfumes. The Company also offers makeup brushes and tools, and makeup bags and cases.


PRICE/SALES RATIO: FAIL

The prospective company should have a low Price/Sales ratio. Non-cyclical companies with Price/Sales ratios greater than 1.5 and less than 3 should not be purchased. ULTA's P/S ratio of 2.84 based on trailing 12 month sales, is above 1.5. If you are currently holding this stock, the P/S ratio is O.K., but if you are thinking about purchasing it, the stock would fail this methodology's first criterion.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. ULTA's Debt/Equity of 0.00% is exceptional, 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. ULTA 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: No Interest in ULTA At this Point

Is ULTA a "Super Stock"? NO


Price/Sales Ratio: FAIL

The Price/Sales ratio is the most important variable according to this methodology. The prospective company should have a low Price/Sales ratio. ULTA's Price/Sales ratio of 2.84 does not pass this criterion.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. ULTA's inflation adjusted EPS growth rate of 29.25% passes this 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. ULTA's free cash per share of 5.46 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. ULTA's three year net profit margin, which averages 8.68%, passes this criterion.

MSG NETWORKS INC

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

MSG Networks Inc., formerly The Madison Square Garden Company, is engaged in sports production, and content development and distribution. The Company owns and operates two regional sports and entertainment networks, MSG Network (MSGN) and MSG+, collectively MSG Networks. Its networks are distributed throughout its territory, which includes all of New York State and significant portions of New Jersey and Connecticut, as well as parts of Pennsylvania. The Company delivers live games of the New York Knicks (the Knicks) of the National Basketball Association (NBA); the New York Rangers (the Rangers), New York Islanders (the Islanders), New Jersey Devils (the Devils) and Buffalo Sabres (the Sabres) of the National Hockey League (NHL); the New York Liberty (the Liberty) of the Women's National Basketball Association; the New York Red Bulls (the Red Bulls) of Major League Soccer (MLS), and the Westchester Knicks of the National Basketball Association Developmental League.


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. MSGN's profit margin of 41.86% 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. MSGN, with a relative strength of 91, satisfies this test.


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

Companies must demonstrate both revenue and net income growth of at least 25% as compared to the prior year. These growth rates give you the dynamic companies that you are looking for. These rates for MSGN (14.81% for EPS, and 4.45% for Sales) are not good enough to pass.


INSIDER HOLDINGS: FAIL

MSGN's insiders should own at least 10% (they own 3.38%) of the company's outstanding shares. This does not satisfy the minimum requirement, and companies that do not pass this criteria are less attractive.


CASH FLOW FROM OPERATIONS: PASS

A positive cash flow is typically used for internal expansion, acquisitions, dividend payments, etc. A company that generates rather than consumes cash is in much better shape to fund such activities on their own, rather than needing to borrow funds to do so. MSGN's free cash flow of $2.73 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

MSGN's profit margin has been consistent or even increasing over the past three years (Current year: 41.46%, Last year: 24.78%, Two years ago: 1.16%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise.


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 MSGN's case.


CASH AND CASH EQUIVALENTS: PASS

MSGN's level of cash $205.3 million passes this criteria. If a company is a cash generator, like MSGN, 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 MSGN was 18.09% last year, while for this year it is 17.62%. Since the AR to sales is decreasing by -0.47% the stock passes this criterion.


LONG TERM DEBT/EQUITY RATIO: PASS

MSGN's trailing twelve-month Debt/Equity ratio (0.00%) is at a great level according to this methodology because the superior companies that you are looking for don't need to borrow money in order to grow.


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

The "Fool Ratio" is an extremely important aspect of this analysis. If the company's Fool Ratio is between 0.5 and 0.65 (MSGN's is 0.51), the company demonstrates excellence in its fundamentals and have soundly beat the earnings estimates. MSGN passes this test.

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

AVERAGE SHARES OUTSTANDING: PASS

MSGN has not been significantly increasing the number of shares outstanding within recent years which is a good sign. MSGN currently has 76.0 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: FAIL

Companies with sales less than $500 million should be chosen. It is among these small-cap stocks that investors can find "an uncut gem", ones that institutions won't be able to buy yet. MSGN's sales of $703.7 million based on trailing 12 month sales, are too high and would therefore fail the test. It is companies with $500 million or less in sales that are most likely to double or triple in size in the next few years.


DAILY DOLLAR VOLUME: PASS

MSGN passes the Daily Dollar Volume (DDV of $11.9 million) test. It is required that this number be less than $25 million because these are the stocks that remain relatively undiscovered by institutions. "You'll be scoring touchdowns against the big guys on your turf."


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. MSGN with a price of $27.58 passes the price test, even though it doesn't fall in the preferred range. The price should be above $7 in order to eliminate penny stocks and below $20 since most stocks in this price range are undiscovered by the institutions.


INCOME TAX PERCENTAGE: FAIL

MSGN's income tax paid expressed as a percentage of pretax income either this year (-5.96%) or last year (39.31%) is below 20% which is cause for concern. Because the tax rate is below 20% this could mean that the earnings that were reported are unrealistically inflated due to the lower level of income tax paid. However, we have utilized a sophisticated formula so that the appropriate figures reflect a 'normal' tax rate (35%).

MAXIMUS, INC.

Strategy: Patient Investor
Based on: Warren Buffett

MAXIMUS, Inc. provides business process services (BPS) to government health and human services agencies. The Company operates through three segments: U.S. Federal Services, Health Services and Human Services. The U.S. Federal Services segment provides BPS and program management for large government programs, independent health review and appeals services for both the United States Federal Government, and state-based programs and technology solutions for civilian federal programs. The Health Services segment provides a range of BPS, as well as related consulting services, for state, provincial and national government programs. The Human Services segment provides national, state and local human services agencies with a range of BPS and related consulting services for welfare-to-work, child support, higher education and K-12 special education programs.

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 0.38, 0.75, 0.97, 1.16, 1.09, 1.67, 2.10, 2.35, 2.69, 3.17. Buffett would consider MMS's earnings predictable, although earnings have declined 1 time(s) in the past seven years, with the most recent decline 6 years ago. The dips have totaled 6.0%. MMS's long term historical EPS growth rate is 18.6%, based on the average of the 3, 4 and 5 year historical eps growth rates, and it is expected to grow earnings 12.5% 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. MMS 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 MMS, over the last ten years, is 20.2%, 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 10.1%, 17.8%, 19.6%, 20.9%, 16.5%, 21.6%, 25.2%, 25.1%, 23.5%, 22.0%, and the average ROE over the last 3 years is 23.5%, 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 MMS, over the last ten years, is 19.1% and the average ROTC over the past 3 years is 19.9%, 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 10.1%, 17.8%, 19.5%, 20.8%, 16.4%, 21.6%, 25.2%, 18.7%, 19.2%, 22.0%, 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. MMS's free cash flow per share of $4.33 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 $14.37 and compares it to the gain in EPS over the same period of $2.79. MMS's management has proven it can earn shareholders a 19.4% 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. MMS's shares outstanding have fallen over the past five years from 68,529,999 to 65,000,000, 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 MMS 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 $3.05 and divide it by the current market price of $69.77. An investor, purchasing MMS, could expect to receive a 4.37% initial rate of return. Furthermore, he or she could expect the rate to increase 12.5% 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 3.25%. Compare this with MMS's initial yield of 4.37%, which will expand at an annual rate of 12.5%, 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]

MMS currently has a book value of $16.85. It is safe to say that if MMS can preserve its average rate of return on equity of 20.2% and continues to retain 86.52% of its earnings, it will be able to sustain an earnings growth rate of 17.5% and it will have a book value of $84.50 in ten years. If it can still earn 20.2% on equity in ten years, then expected EPS will be $17.09.


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

Now take the expected future EPS of $17.09 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (22.9) (5 year average P/E in this case), which is 21.0 and you get MMS's projected future stock price of $357.95.


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 $8.32. This gives you a total dollar amount of $366.27. These numbers indicate that one could expect to make a 18.0% average annual return on MMS's stock at the present time. Buffett would consider this a great return.


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

If you take the EPS growth of 12.5%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $9.90. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio or current P/E ratio (22.9) (5 year average P/E in this case), which is 21.0. This equals the future stock price of $207.50. Add in the total expected dividend pool of $8.32 to get a total dollar amount of $215.81.


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 $69.77 and the future expected stock price, including the dividend pool, of $215.81. If you were to invest in MMS at this time, you could expect a 11.95% 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 12.0% and 18.0%. 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 15.0% on MMS stock for the next ten years, based on the current fundamentals. Buffett likes to see a 15% return, but nonetheless would accept this return, thus passing the criterion.


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