Market Legends: A "Hot List" Trio

05/30/2016 10:00 am EST


John Reese

Founder and CEO, And Validea Capital Management

John Reese, editor of Validea, analyzes the investment strategies of the stock market’s most legendary investors and builds model portfolio based on these strategies. Here, he explains his approach and highlights a trio of stocks that make it on to his Hot List of buys.

Steve Halpern:  Joining us today is John Reese, editor of Validea.  How are you doing today, John?

John Reese:  Great.  Thank you, Steven.

Steve Halpern:  Now, you continually analyze stocks based on the investment strategies of the market’s most legendary investors.  Could you give our listeners a quick overview of how this approach works and the kind of market experts that you traditionally follow?

John Reese:  I have identified and read the books of legendary investors in the United States over the last 100 years including Peter Lynch, Benjamin Graham, Warren Buffet, and several others and have extracted the wisdom in their books and created computerized, artificial intelligence models that picks out stocks from the current stock market in the way they said they did it at a time when they were growing their companies or funds.  

Steve Halpern:  Now, you recently shared some fascinating commentary with your readers regarding small caps versus large caps and the valuations of those two sectors.  Could you explain this analysis and what portends to the current investing landscape?

John Reese:  Sure.  What I found based upon analysis stocks going back to 2005 is that the average price earnings ratios and price of sales ratios, the two measurements of value, of large cap stocks have been higher only a tiny fraction of the time, only 6% of the time using those particular ratios.  

Those large cap stocks are currently trading at over 20% premium to the long-term average.  Small cap stocks are trading at a slight premium based upon the same analysis.  

When you combine the two, the ratio of long term versus small term, in our history and our research, we found that only 4.4% of the time have large cap stocks been so expensive relative to small cap stocks, so what does that portend?  

This means that for long-term strategic investors small caps now offer statistically a chance of a much better opportunity over the long term.  What do I mean by the long term?  

I’m talking about somebody with a five to ten-year perspective, this makes a great time to go heavier on small cap stocks and lighten up on large cap stocks, and by large cap that also includes indexes like the S&P 500 which are heavily weighted toward large and mega cap stocks right now.

Steve Halpern:  Now speaking of the indexes, I was particularly intrigued by your recent commentary on the impact of index funds on mega caps and how this in turn might be impacting the valuation of the overall markets.  Could you explain what you meant by that?

John Reese:  Yes, it’s very interesting, but if you look at just the top 10 holdings out of the S&P 500, so 10 out of 500 stocks actually have more weight collectively in the index than the 300 smaller holdings, so 300 out of the 500 stocks, so what does that actually mean.  

For instance, if the 300 stocks go down by 1% and your top 10 stocks go up by 2% over the same period of time, the market average will show that the market is up by an average of 1% even though the overwhelming majority of the stocks have gone down over the same period of time.

But right now and particularly in the last year, the very, very biggest stocks, the top 10 stocks and also the “FANG” stocks have gone up substantially thereby lifting the index hugely based upon the weight of just those stocks whereas the vast majority of the stocks went down.  

The implication for this at some point in time that will reverse due to one or more of the stocks becoming unpopular for a variety of reasons and will dramatically drive down the most popular large cap indexes like the S&P 500.

Steve Halpern:  So turning to some specific stocks, you maintain what you call your hot list portfolio.  Could you explain how you compile this group of stocks?

John Reese:  Um, yes.  The hot list portfolio, we look at all of our guru strategies and in some, I actually have a total of 22 combined -- both public and behind the closed doors so to speak.

And I weight each of those strategies by their long-term risk adjusted performance, and they will look at 6,000 stocks in the stock market and assign each one a ranking.  The hot list consists of the top 10 stocks according that ranking.  

Steve Halpern:  Now does the impact of stocks rank if it’s recommended by more than one of the market gurus you follow?

John Reese:  The answer is yes.  As more gurus like it and particular as the heavier weighted gurus like it, that definitely increases the likelihood or chance that it’s picked as part of the top 10.

Steve Halpern:  Now will you highlight a few stocks that currently make it onto your hot list portfolio?

John Reese:  I’d be happy to.  This list was updated recently, but one of the new ones is called Comfort Systems (FIX), and they’re a provider of HVAC and mechanical services.  

It’s a small cap stock, market cap about 1.1 billion, price earnings ratio of 21, and it gets top scores right now based on our Peter Lynch, Ken Fisher, and the Meta Model so it’s actually an example of a stock that showing both value and growth and momentum characteristics.  

A second one is Home Bank Shares (HOMB).  They’re a bank holding company with a market cap of just under $3 billion and it gets top scores from our Peter Zweig and momentum models and it’s a top mid-cap growth name in our Validea investing system.  

A third pick is Thor Industries (THO).  They’re the manufacturer of recreational vehicles, market cap of about 3 billion and that gets a some or strong interest score from over seven of our models at this time.

So it’s a combination of attractive value, growth, relative strength, and makes it a top pick.  Now, we’ve been actually holding that in the hot list for a few months and it’s up about 25% on the positions so far.

Steve Halpern:  Again, our guest is John Reese of Validea.  Thank you for your time today.

John Reese:  Thank you, Steven.

By John Reese, Editor of Validea

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