John Reese's Hot List is made up of stocks that score highest based on models that mimic the investment strategies of a variety of market gurus; here, the editor of Validea highlights a new buy that ranks highly on models designed around Peter Lynch, Joel Greenblatt, and Warren Buffett.
Steven Halpern: Joining us today is John Reese, Editor of Validea. How are you doing today, John?
John Reese: Great, thanks. Thanks for inviting me.
Steven Halpern: You have a fascinating newsletter service in which you select stocks based on the strategies of legendary investors. Could you give our listeners a little background about this service?
John Reese: Yes, about 20 years ago, I started asking myself the question, “who were the legendary investors in the US stock market who had very substantial track records and who also wrote a book about how they went about picking stocks that made them successful?”
I was then able to use some background computer techniques and have computerized models of each of those legendary investors. At this point in time, I now have 17 such gurus.
I built two businesses off of it, one is a newsletter that picks stocks using those strategies and the other that manages money for investors for them on a personal one-to-one basis.
Steven Halpern: Now, within your newsletter you maintain what you call your Hot List and before we look at a new addition to this list, could you explain your procedure for adding recommendations to this list of stocks?
John Reese: Yes, the Hot List consists of stocks that get the highest scores from multiple guru models and those are models—I actually weight them differently—the models that have the best long-term risk-adjusted performance actually count higher in the vote of the weighting for each of the stocks.
The portfolios are rebalanced; once every 28 days, I select the top ten highest stocks and the balancing therefore, insures that the stocks are improving in score and gets rid of the stocks that have lower scores or going down.
Steven Halpern: Now, one of the latest additions to this Hot List is luxury goods retailer Coach (COH). Could you give us some background on this?
John Reese: Sure. Coach is a five billion dollar sales firm that has very fashionable handbags for women and men and quite a variety of other accessories. They also sell in some 25 countries around the world, usually under stores in their own name.
Steven Halpern: Now, you know that Coach has scored highly on several of your investment models, including your Peter Lynch model and your Joel Greenblatt based model. Could you tell us a little about those two models and how this fits in?
John Reese: Sure. Peter Lynch was the chairman and the portfolio manager for the famed Magellan Fund, which grew to be the biggest mutual fund in the world. He had several different selection criteria depending upon whether the stock was classified as a fast grower, a slow grower, or soured in between.
|pagebreak|In this particular case, he would say that Coach is a medium growth type company and applied several different criteria, in terms of, assessing the value of the company and its financial strengths.
Joel Greenblatt is interesting that he uses two variables—just two sophisticated variables—and ranks all of the companies.
The companies that score in the very top of the combined ranking of the two variables, some are based on earnings yield, others based on the use of the capital. Those that rank very highly have gone on to do very well in the stock market. Those are the two different models.
Steven Halpern: Now, you also note in your latest research that Coach is now scoring at the top of the ratings model for your Warren Buffett based approach. Could you walk us through some of the criteria for the Buffett model?
John Reese: Sure. The Buffett Model is one of the most sophisticated models with number of criteria. It first looks to see that it's a “Buffett type company” and that is, that it has either low-cost production or durable competitive advantage, which, in this case for Coach, it is a very strong worldwide brand name.
Another key feature of the Buffett analysis is it looks for earnings consistency and predictability. In this case, Coach, for instance, in nine of the last ten years has increased its earnings per share.
Buffett also wants to see high return on equity, wants to see very conservative use of debt, it wants to see that management is buying back shares.
Once all of that is actually done, it then uses, actually, two different was to calculate a reasonable future projection of the earnings per share of growth and the worth of the company a decade down the line.
Now remember, you can't do this with most companies, but one key criteria here was that Buffett was looking for smooth, steady, predictable earnings per share, which Coach has.
Steven Halpern: In the case of Coach, where it is scoring highly in three of your different models, first, is it typical that three models would hone in on the same stock and does the fact that three models like it make the stock more attractive to you now?
John Reese: There are a small set of stocks in the market that get strong interest, like Coach, from multiple strategies, so, on the Validea side, I can actually screen for this in real time and, as of a couple days ago, there were only six stocks to get 90% plus scores for three or more of the strategies.
The Hot List model portfolio seeks out the stocks to get the high scores from the multiple models. Since I launched the portfolio in July of 2003, the models returned 11.3% annually versus only 6.2% for the S&P 500 (SPX) , so almost double the market. Again, a lot of that is because multiple gurus like the same stock.
Steven Halpern: Well, we really appreciate you taking the time today. Thanks for joining us.
John Reese: You are very welcome, Steven.
