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Executive Summary December 5, 2014

The Economy

While tumbling oil prices are worrying some investors, the US economy is continuing to push ahead at a solid pace.

Private payroll processor ADP said the private sector added 208,000 jobs in November, for example, right in line with the 205,000 average for the first ten months of the year. ADP also revised its October jobs-added estimate slightly higher, from 230,000 to 233,000. The Labor Department is slated to announce its November jobs numbers today, and investors will no doubt be keeping a close eye on the report.

New claims for unemployment have risen just a bit over the past two weeks, but in the most recent week were still 8.6% lower than they were in the year-ago period. Continuing claims, the data for which lag new claims by a week, edged very slightly upward since our last newsletter but are 16.5% below year-ago levels.

Manufacturing and service sector data also remains very strong. The Institute for Supply Management said manufacturing activity increased in November for the 18th straight month, doing so at about the same rate it did in October. In only two months this year has the rate of increase been higher. The sub-index for new orders remained at an extremely high level, while the employment sub-index remained at a very healthy level. For the second straight month, the prices sub-index declined rather sharply. The November reading indicated that raw materials prices declined for the first time since July 2013. A big part of that is the sharp drop in oil prices we've seen lately.

ISM also said the service sector expanded in November for the 58th straight month, doing so at an accelerating pace. The new orders sub-index rose a bit while the employment sub-index fell a bit, but both remained at high levels.

Elsewhere, new home sales edged higher by 0.7% in October, according to a new government report. That put them 2.8% above year-ago levels.

The latest consumer data from the Commerce Department showed that personal income rose 0.2% in October. Real disposable personal income was up 0.1%, while real personal consumption expenditures rose 0.2%. The personal savings rate remained at a very solid 5.0%.

Gas and oil prices, meanwhile, keep tumbling. This past week, US crude fell to its lowest level since July 2009. As for gas, a gallon of regular unleaded on average cost $2.75 as of Dec. 3, down 23 cents from a month earlier, according to AAA. As I noted last month, in an environment in which wage growth has been meager, the gas price declines should give consumers a bit of a boost. But it is a double-edged sword. The energy sector is a big facilitator of job growth, and at some point, if the lower prices lead to less production, all of this could have an impact on the jobs market

Since our last newsletter, the S&P 500 returned 0.9%, while the Hot List returned 1.3%. So far in 2014, the portfolio has returned -11.3% vs. 12.1% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 222.7% vs. the S&P's 107.1% gain.

Portfolio Update

It's been a pretty calm fortnight for the broader market and the Hot List, with the portfolio notching decent gains since our last newsletter (as of mid-afternoon trading on Thursday). Eight of the portfolio's 10 holdings were in the black, with Universal Insurance Holdings leading the way with a 6.6% gain. Not far behind was The Middleby Corporation, which was up 4.5%. The two laggards -- AGCO and Credit Acceptance -- were down just 1.3% and 1.7%, respectively.

Universal's jump seemed to be the result of the Dec. 2 announcement that it sold 1 million registered shares of common stock, in a privately negotiated transaction, to Ananke Catastrophe Investments Ltd., an affiliate of Nephila Capital Ltd. Company officials said that by using shares held in treasury from prior repurchases, the transaction would immediately increase Universal's book value per share by 7%. It will also allow the firm to use the proceeds to accelerate its organic growth strategy through both the continued geographic expansion outside its home state of Florida and further quota share reduction.

A couple other Hot List holdings announced earnings, though shares of both have been relatively flat since our last newsletter. One was Foot Locker, which announced third-quarter earnings that topped analysts' estimates and were up 22.1% from the prior-year quarter. The improvement was driven by a 6.9% rise in comparable-store sales, and revenues also topped analysts' estimates, according to Zacks Investment Research. Zumiez Inc. also reported third-quarter earnings and revenues that beat analysts' expectations.

Two weeks from now, we'll rebalance the portfolio for the final time in 2014. At that point we'll see if Foot Locker's and Zumiez's solid earnings will help keep them in the Hot List as we move into the New Year.

Editor-in-Chief: John Reese

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Guru Spotlight: Benjamin Graham

Today, many investors look to Warren Buffett for advice about the stock market and the economy. But before he became one of the world's richest men and greatest investors, there was someone whose investment advice Buffett himself cherished: Benjamin Graham. And Buffett was far from alone. Known as "The Father of Value Investing", Graham inspired a number of famous "sons" -- Mario Gabelli, John Neff, John Templeton, and, most famously, Buffett are all Graham disciples who went on to their own stock market greatness.

So, just who was Graham? Born in England in 1894 as Benjamin Grossbaum (his family later changed its surname to Graham during World War I, when German names were viewed with suspicion), Graham built his reputation -- and fortune -- by using an extremely conservative, low-risk approach to investing. To him, preserving one's original capital was every bit as important as netting big gains, and two factors from his early years may show why. The first was Graham's own family's fall from financial comfort to poverty not long after his father died when he was nine. The second involved his first major business venture, an investment firm he founded with Jerome Newman. Just three years after opening, the stock market crash of 1929 and the Great Depression arrived. Graham's clients, like just about everyone else, were hit hard, according to Graham biographer Janet Lowe, and Graham worked without compensation for five years until his clients' fortunes were fully restored.

Having lived through both his own family's financial troubles and the market crash, it's no surprise that the strategy Graham laid out in his classic book The Intelligent Investor was a conservative, loss-averse approach. To Graham, an investment wasn't something that could be turned into quick, easy profits; anything that offers such "easy" rewards also comes with substantial risk, and Graham abhorred risk. True "investment", he wrote, deals with the future "more as a hazard to be guarded against than as a source of profit through prophecy."

In terms of specifics, Graham's "Defensive Investor" approach limited risk in a number of ways, and my Graham-based model lays out several of those methods. For example, one key criterion is that a firm's current ratio -- that is, the ratio of its current assets to its current liabilities -- is at least 2.0, showing that the firm is in good financial shape. The approach also targets financially sound firms by requiring that long-term debt not exceed net current assets. Two other criteria the Graham method uses to find low-risk plays: the price/earnings ratio and the price/book ratio. Graham wanted P/E ratios to be no greater than 15 (and, as another signal of his conservative style, he looked not only at trailing 12-month earnings but also at three-year average earnings, to ensure that one-year anomalies didn't skew the P/E ratio). For the price/book ratio, he used a more unusual standard: He believed that the P/E ratio multiplied by the P/B ratio should be no greater than 22.

My Graham-inspired strategy tends to find bargains across a variety of areas of the market. Here are the current holdings of the 10-stock Graham portfolio:

Cheung Kong Holdings Limited (CHEUY)
National-Oilwell Varco (NOV)
Carbo Ceramics (CRR)
Reliance Steel & Aluminum Co. (RS)
Universal Corporation (UVV)
Sasol Limited (SSL)
AGCO Corporation (AGCO)
The Buckle, Inc. (BKE)
Liquidity Services, Inc. (LQDT)
Tech Data Corp. (TECD)

Two types of stocks that you won't find in the Graham portfolio are technology and financial firms. Graham excluded tech stocks from his holdings because they were too risky, and, while many are not as risky today, I do the same. Financial stocks, meanwhile, aren't explicitly excluded from my Graham model. But because of the low-debt requirements in this strategy, it's nearly impossible for a financial firm to garner approval.

Since I started tracking my Guru Strategies nearly 10 years ago, the performance of my Graham-based model has been rather remarkable. Even though the strategy Graham outlined is now more than 60 years old, it just keeps on working. Through Dec. 3, the 10-stock Graham-based portfolio was up 279.4% since its July 2003 inception, making it one of my best 10-stock performers. That's a 12.4% annualized return in a period in which the S&P 500 has gained just 6.6% per year. The model's strict balance sheet criteria helped it avoid big losers in 2008, as the portfolio lost less than half of what the broader market lost, and it rebounded big in 2009 and 2010.

After two strong years -- the Graham portfolio gained 33.8% in 2012 and 41.4% in 2013 -- the Graham approach has struggled in 2014. It's down 20.5%, a figure that would make for its worst year ever. Even the best strategies go through rough periods; given its exceptional long-term track record, however, I expect that this subpar performance in 2014 is just a blip on the radar for the Graham portfolio.

Overall, the Graham strategy's long-term results are a great demonstration of how successful stock investing doesn't need to be incredibly complex or cutting-edge. You don't need fancy theories or gimmicks; you just need to focus on good companies whose stocks are selling at good values. Do that, and you should produce some strong results of your own.

News about Validea Hot List Stocks

Zumiez Inc. (ZUMZ): On Dec. 4, Zumiez reported fiscal third-quarter earnings of $15.7 million, or 54 cents per share. Adjusting for costs related to mergers and acquisitions, EPS were 56 cents. Those figures beat analysts' expectations of 52 cents per share, the Associated Press reported. Zumiez's revenue was $213.3 million, beating analysts' estimates of $211.5 million.

AmTrust Financial Services, Inc. (AFSI): On Nov. 24, AmTrust announced that it had entered into a definitive agreement, pending regulatory approval, to acquire for cash CorePointe Insurance Company, a wholly-owned subsidiary of CorePointe Group LLC. Birmingham, Mich.-based CorePointe is a specialty property/casualty insurance company that markets commercial package insurance products primarily to automobile and motorcycle dealerships and auto repair shops. The dollar value of the deal was not disclosed. AmTrust said the move is expected to be immediately accretive.

The Next Issue

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

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

AFSI   |   UVE   |   CACC   |   VLO   |   ZUMZ   |   PJC   |   AGCO   |   MIDD   |   JLL   |   FL   |  

Amtrust Financial Services, Inc. (AmTrust) underwrites and provides property and casualty insurance. The Company operates in three business segments: Small Commercial Business, Specialty Risk and Extended Warranty and Specialty Program. Small Commercial Business segment provides workers' compensation to small businesses that operate in low and medium hazard classes, such as restaurants, retail stores, physicians and other professional offices, and commercial package and other property and casualty insurance products to small businesses. The Company's Specialty Risk and Extended Warranty segment provides coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans. The Company's Specialty Program segment provides workers' compensation, package products, general liability, commercial auto liability, excess and surplus lines programs and other specialty commercial property and casualty insurance

Universal Insurance Holdings, Inc. (UIH) is a vertically integrated insurance company. The Company's insurance products are offered to the Company's customers through Universal Property & Casualty Insurance Company (UPCIC) and American Platinum Property and Casualty Insurance Company (APPCIC), (collectively the Insurance Entities). Substantially all aspects of insurance underwriting, distribution and claims processing are covered through the Company's subsidiaries. Blue Atlantic Reinsurance Corporation (BARC), a wholly owned subsidiary of UIH, is a reinsurance intermediary broker. The Insurance Entities generate revenues primarily from the collection of premiums. Universal Risk Advisors, Inc. (URA), the Company's managing general agent, generates revenue through policy fee income and other administrative fees from the marketing of the Insurance Entities' insurance products through its distribution network of independent agents.

Credit Acceptance Corporation (Credit Acceptance) is a provider of auto loans to consumers. The Company offers auto loans and related products and services to consumers through its network of Dealer-Partners. It refers to dealers who participate in the Company's programs as Dealer-Partners. Credit Acceptance has two programs: the Portfolio Program and the Purchase Program. Under the Portfolio Program, it advances money to Dealer-Partners (referred to as a Dealer Loan) in exchange for the right to service the underlying Consumer Loans. Under the Purchase Program, Credit Acceptance buys the Consumer Loans from the Dealer-Partners (referred to as a Purchased Loan) and keeps all amounts collected from the consumer. Dealer Loans and Purchased Loans are collectively referred to as Loans.

Valero Energy Corporation (Valero) is an independent petroleum refining and marketing company. Valero's refineries can produce conventional gasoline's, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products, as well as a slate of premium products, including conventional blendstock for oxygenate blending and reformulated gasoline blendstock for oxygenate blending, gasoline meeting the specifications of the California Air Resources Board, a diesel fuel, and low-sulfur and ultra-low-sulfur diesel fuel. It also owns 10 ethanol plants in the central plains region of the United States with a combined ethanol nameplate production capacity of about 1.1 billion gallons per year. It operates in three business segments: refining, ethanol, and retail. In May 2013, CST Brands Inc announced that the Company which includes Corner Store and Depanneur du Coin, spun off from Valero Energy Corporation.

Zumiez Inc. (Zumiez) is a specialty retailer of action sports related apparel, footwear, equipment and accessories operating under the Zumiez brand name. As of January 28, 2012, the Company operated 434 stores in the United States and 10 stores in Canada. In addition, the Company operates a Website that sells merchandise online. At January 28, 2012, its stores averaged approximately 2,900 square feet. Its apparel offerings include tops, bottoms, outerwear and accessories, such as caps, bags and backpacks, belts, jewelry and sunglasses. Zumiez's footwear offerings primarily consist of action sports related athletic shoes and sandals. Its equipment offerings, or hardgoods, include skateboards, snowboards and ancillary gear, such as boots and bindings. The Company also offers a selection of other items, such as miscellaneous novelties.

Piper Jaffray Companies is an investment bank and asset management firm, serving the needs of corporations, private equity groups, public entities, non-profit entities and institutional investors in the United States and internationally. The Company operates in two segments: Capital Markets and Asset Management. The Capital Markets segment provides investment banking and institutional sales, trading and research services for various equity and fixed income products. The Asset Management segment includes traditional asset management activities and related services. The Company markets the investment banking and institutional securities business under Piper Jaffray name. Its asset management business is marketed under Advisory Research, Inc. In July 2013, Piper Jaffray Companies announced that it has completed its purchase of Seattle-Northwest Securities Corporation. In July 2013, the Company announced that it has completed its purchase of Edgeview Partners L.P.

AGCO Corporation is engaged in manufacturing and distributing agricultural equipment and related replacement parts throughout the world. The Company sells a range of agricultural equipment, including tractors, combines, self-propelled sprayers, application equipment, hay tools, forage equipment, tillage, implements, engines, precision farming technologies, grain storage and protein production systems, and replacement parts. Its products are used in the agricultural equipment industry and are marketed under a number of brands, including Challenger, Fendt, GSI, Massey Ferguson and Valtra. The Company distributes most of its products through a combination of approximately 3,100 independent dealers and distributors in more than 140 countries. In addition, the Company provides retail financing, through its retail finance joint ventures with Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A. (Rabobank).

The Middleby Corporation (Middleby) through its operating subsidiary Middleby Marshall Inc. (Middleby Marshall) and its subsidiaries, is engaged in the design, manufacture, marketing, distribution, and service of a line of cooking and warming equipment used in all types of commercial restaurants and institutional kitchens, and food preparation, cooking and packaging equipment for food processing operations. The Company operates in two segments: the Commercial Foodservice Equipment Group and the Food Processing Equipment Group. In April 2014, Middleby Corporation acquired assets of Processing Equipment Solutions, Inc. In September 2014, Middleby Corporation acquires Concordia Coffee Company, Inc.

Jones Lang LaSalle Incorporated (Jones Lang LaSalle), is a financial and professional services firm specializing in real estate. Jones Lang LaSalle has over 200 corporate offices worldwide and operations in more than 1,000 locations in 70 countries. The Company offers integrated real estate and investment management services on a local, regional and global basis to owner, occupier and investor clients. It delivers an array of Real Estate Services (RES) across its three geographic business segments: the Americas, Europe, Middle East and Africa (EMEA), and Asia Pacific. LaSalle Investment Management, a wholly owned member of the Jones Lang LaSalle group that consists of its fourth business segment, is a diversified real estate investment management company. In July 2014, Jones Lang LaSalle Inc acquired CLEO Construction Management (CLEO), a construction project management services firm that specializes in medical facilities.

Foot Locker, Inc. is a global retailer of athletic shoes and apparel. As of August 02, 2014, the Company operated 3,460 stores, including 74 franchised stores. The Company operates in two segments. The Athletic Stores segment is an athletic footwear and apparel retailer whose formats include Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports, Footaction and SIX:02, as well as the retail stores of Runners Point Group, including Runners Point, Sidestep and Run2. The Direct-to-Customers segment operates the websites for eastbay.com, final-score.com, eastbayteamsales.com, ccs.com, as well as websites aligned with the brand names of its store banners (footlocker.com, ladyfootlocker.com, kidsfootlocker.com, champssports.com, footaction.com, and six02.com). Additionally, this segment includes the direct-to-customer subsidiary of Runners Point Group, which operates the websites for runnerspoint.com, sidestep-shoes.com, and sp24.com.

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.

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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.