Ascendere Associates LLC J.

Stephen Castellano

www.ascenderellc.com steve@ascenderellc.com

Ascendere Weekly Ranking Update: October 22, 2010
Every week, we include in this report a list of the highest quality and lowest quality stocks as defined by four key factors: 1) Relative Value; 2) Operating Momentum; 3) Analyst Revision Momentum; and 4) Fundamental Quality. At the end of each month, we take roughly 1/3 of the stocks on this list to construct our various long/short and long-only model portfolios, which are rebalanced monthly. But as you can read below, there are several other ways to use this data. This week, 62 stocks make the "high-quality" list, with 18 additions and 18 deletions. 42 stocks make the "low-quality" list, with 6 additions and 7 deletions to our "low-quality" list. In our opinion, American Express (AXP) is the most important new "high-quality" stock this week.

Three ways to use this newsletter:
1) Build our own hedge fund Use data in this report at discretion or as an enhancement to our model portfolio strategy newsletter. 2) Anticipate sell side research ratings changes It is not uncommon to find these stocks presaging changes to sell side price targets, ratings or conviction lists. See our "Nostradamus" report. 3) Generate relevant long-term ideas for further study Buy and hold still does work. We do the heavy lifting and find you "high-quality" stocks; you provide the incremental research time and effort.

Examples of some recent sell side actions
   Our 10/15 newsletter highlighted The Chubb Corp. (CB) and on 10/22 Credit Suisse raised its price target on CB to $61 from $56. On 10/8, we highlighted Freeport McMoRan (FCX) and since then we have counted at least five price target increases by the sell side. On 9/24, Assured Guarantee (AGO) appeared in our Weekly report as a "high-quality" stock idea, and a week later on 10/1 we purchased it for our portfolio. On 10/20 Zacks listed it as a #1 Rank Pick, but by that time it has already run up by more than 20% in our portfolio. October 22, 2010 steve@ascenderellc.com

Ascendere Associates LLC J. Stephen Castellano

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Highlighted Stock Ideas
"High-Quality" Stocks 61 "high-quality" stocks make our weekly ranking update report this week, flat with the 61 reported last week. However, there are 18 new names to the list and 18 deletions. Rankings can be volatile during earnings season as new fundamental data is gradually updated. We define quality as relative to four key factors: 1) Relative Value; 2) Operating Momentum; 3) Analyst Revision Momentum; and 4) Fundamental Quality. About 1/3 of these stocks make it to our model portfolios that turnover monthly, but we think some of these stock ideas could work well with average 12-month holding periods as well. Our opinion is based on a backtest we conducted back to 12/31/2004, which showed that 12-month returns from stocks on refined list averaged about 11%, with the highest 12-month returns averaging +95% and the lowest 12-month returns averaging -42%. Deeper fundamental analysis of stocks on this list might reveal some of the stronger, longer-term ideas. Of the 18 new "high-quality" stock ideas this week, five of them stand out to us. These include RenaissanceRe Holdings Ltd. (RNR), American Express Company (AXP), Gilead Sciences Inc. (GILD), Union Pacific Corporation (UNP) and Telecom Argentina S A (TEO). RenaissanceRe Holdings Ltd. (RNR) is a "global provider of reinsurance and insurance to cover the risk of natural and man-made catastrophes." This $3.8b market cap company is trading at 1.05x tangible book value and 7.6x the consensus calendar-year 2011 EPS estimate of $7.95, and is yielding 1.6%. It reports 3Q10 results on Thursday morning, October 28, 2010. The company states in its 2009 annual report that the most important metric by which it measures shareholder value is tangible book value per share plus the change in accumulated dividends. This company has a history of raising dividends each year by $0.04 per share; its latest annualized dividend is $1.00, up from $0.96 in 2009. The stock has traded between 0.81x to 2.11x tangible book over the last 7 years, and in 2008 and 2009 traded at an average tangible book value of 1.21x and 1.19x. RNR stock got our attention because it is only two of the 18 new adds that scored the best possible score in 3 out of 4 factors, and the second highest score for a fourth. Based on forward looking estimates, it looks like operating momentum may have peaked in the June 2010 quarter, but given its rising stock price though still low P/BV multiple and rising analyst revision momentum, we wonder if analyst revisions will continue. Perhaps earnings estimates are too low because of overly-high estimates for the cost of Gulf of Mexico cleanup? This is one stock that deserves further study. American Express Company (AXP) is a "go-to" stock in the Financials sector, the same way that Freeport McMoran (FCX) is a go-to stock in Materials. When portfolio managers speak of financials, they always want to know about AXP. We have not been able to say anything good about American Express for a long time, but this may be changing. AXP, a $47b market cap company, is trading at 3.2x book value, 11.0x times the calendar 2011 consensus EPS estimate of $3.55, with an annualized dividend of $0.72 and yield of 1.8%. The stock sold off 3% this past Friday following its 3Q10 report the night before. Revenue and earnings beat consensus, helped in part by rising card usage, lower defaults, and a release of bad debt reserves. That sounds like positive developments to us, but a number of analysts expressed concern about higher expenses and increasing risk of a decline in its merchant discount rate and ongoing pressure related to the Credit Card Accountability, Responsibility and Disclosure Act. These risks are real, but perhaps embedded enough in current valuations, likely ongoing analyst revision momentum and relatively low but still likely positive operating momentum. In our opinion, AXP as of today, looks like one of the best relative Financial Sector stocks out there and deserves a look as both a short-term and long-term holding idea.

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com

We are glad to see Gilead Sciences Inc. (GILD) back on our "high-quality" list after a six-month hiatus. On April 21 of this year, GILD sold off nearly 10% to $40.76 after reporting a good quarter but reduced guidance, compelling us to write a "screaming buy" report on the shares. The crux of our argument was that despite a near-term peak in operating momentum and long-term uncertainty with its drug pipeline, given its strong ROIC profile and a PE multiple of 11.8x our "ultra worst case estimate" of $3.45 for calendar year 2011 EPS, GILD was severely undervalued. Apparently as punishment for making a call that was probably contrarian to most of the 22 sell side analysts covering this stock, it declined another 22% over the course 4 months to $31.83 on August 31, 2010. Since then the stock has recovered back to $39.11. The stock continues to trade at absurdly low levels -- 9.7x a consensus EPS estimate of $4.04. As a result, we give GILD a score of 5 out of 5 for Relative Value, and Fundamental Quality scores a high-five as well. Analyst Revisions are moving positively again, and we give this metric a score of 4 out of 5. GILD reported a better than expected quarter on October 19, driven by strong HIV treatment sales and its ongoing stock repurchase plan. The Wall Street Journal noted that GILD is trading in line with Merck & Co. (MRK) and Eli Lilly & Co. (LLY). Given Gilead's strong ROIC profile and plenty of breathing room to get a new pipeline prior to major patent expirations in 7 years, GILD's low valuation continues to be one of the most absurd things we have seen in a long time and, as such, is managing one of the few major share repurchase programs that has ever made any sense. With Analyst Revisions trending up again, and a management intent on buying back its undervalued shares, this stock may continue attracting momentum investors. If you liked CSX Corp. (CSX) last week, you will love Union Pacific Corp. (UNP) this week, according to our relative ranking models. Last week, CSX Corp. made our "high-quality" list, but this week it was knocked off as a result of relatively better financial reports from Industrial sector companies, including Union Pacific Corp. At $42.6b, UNP's market cap is nearly twice as large as CSX and now sports a better cumulative factor score than CSX. UPN trades at 13.7x the calendar year 2011 EPS estimate of $6.29 and pays a $1.32 annualized dividend for a yield of 1.4%. UNP is trading at a slight premium to CSX, but this is justified by its strong analyst revision momentum, which scores a 5 out of 5. UNP reported a strong quarter following the market close on October 21, with 3Q10 EPS of $1.56 beating Street consensus of $1.50, driven by better than expected prices and cost control. This prompted a number of positive analyst revisions to estimates and price targets. UNP's debt stands at $9.8b, cash is $1.4b, and its debt-to-capital ratio is decent at 31%. Debt-to-capital would only move up to 39% if it acquired CSX, though we note we have no inkling of the possible synergies between the two or any of the antitrust issues that might be raised. But what better time to make an acquisition, just prior to a possible upturn in the economy and during growing evidence that freight traffic is recovering? If the PE spread ever widens significantly more between the two companies, a M&A analysis might be worth some time. Until then, UNP looks like a solid industrial stock, replacing CSX relative to last week. This week the ADRs of Telecom Argentina SA (TEO) also catch our attention, showing highest scores for Relative Value, Operating Momentum and Fundamental Quality. The company is trading at only 7.8x the consensus 2011 EPS estimate of $2.97 per ADR and has net cash on its balance sheet. It is a mystery to us how any capital intensive company like a telecom can have net cash, but those are the numbers. TEO is growing revenues and earnings at an impressive clip despite reports of a saturated mobile and fixed line telecom market due to value added services. Perhaps Verizon and AT&T ought to pay a visit to TEO; maybe they will learn something. This company deserves further study. Moving Off the "High-Quality" List Of the 18 companies moving off the list, notably are Assured Guarantee (AGO), The Chubb Corporation (CB) and CSX Corp. (CSX). We highlighted CB and CSX last week, but updated financial reports and associated rankings have pushed these stocks off the list again on a relative basis. Assured Guarantee has moved up about 25% MTD in anticipation of benefitting from mortgage putbacks, but analyst revision momentum has declined beneath our cutoff point relative to other Financials. For additional deletions, see our table below.

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com

"Low-Quality" stocks There are 42 "Low-Quality" stocks again this week, with 6 new to the list and 7 moving off. The only potentially notable addition we see here is Alliance Data Systems Corporation (ADS), which is ranked poorly across the board for all factors. Some of the other stocks have been bouncing on and off the "low-quality" list in recent weeks, which we attribute to general noise. Moving Off the "Low-Quality" List Of the 7 stocks moving off our "low-quality" list this week, standing out is Harley Davidson (HOG), moving off the list with a high score for analyst revision momentum -- 4 out of 5. Of Note It is tough to find any solid short ideas among our "low-quality" stocks. For the MTD, low-quality has outperformed high-quality, though that return spread has narrowed over the past few days (see the latest "Ascendere Daily Update" report). When investors anticipate better economic conditions or increase their risk appetite for whatever the reason, "low-quality" tends to outperform in the short-term as these beaten-down stocks begin discounting better fundamentals down the road. Over the long-run, "high-quality" will outperform, but it's very tough to find a compelling short idea among the current "low-quality" list.

Ascendere Associates LLC J. Stephen Castellano

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Data

Daily Return Data of our Model Portfolio Backtests are Available on Request to Paying Subscribers

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October 22, 2010 steve@ascenderellc.com

"High-Quality" Stocks (part 1 of 2)

Ascendere Associates LLC J. Stephen Castellano

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"High-Quality" Stocks (part 2 of 2)

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com

"Low-Quality" Stocks (part 1 of 2)

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com

"Low-Quality" Stocks (part 2 of 2)

Ascendere Associates LLC J. Stephen Castellano

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New to the "High-Quality" List Relative to Last Week

Ascendere Associates LLC J. Stephen Castellano

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Leaving the "High-Quality" List Relative to Last Week

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com

New to the "Low-Quality" List Relative to Last Week

Moving Off the "Low-Quality" List Relative to Last Week

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com

METHODOLOGY
Ascendere Associates LLC quantitative research is based on several factors, including: 1) operating momentum 2) fundamental quality 3) analyst revision momentum; and 4) relative value. A number of these factors are overweighted on what we consider proxies for cash flow growth and return on invested capital. In our opinion these factors provide a good reflection of a company's value relative to other companies in its sector. Daily return data of our backtests are available to paying subscribers upon request. Ascendere currently sources raw financial data from Capital IQ. In our opinion, cash flow growth and return on invested capital are the key drivers of any stock's valuation. By focusing on various proxies for these data points and other factors such as relative value, we have been able to generate some terrific investment ideas and avoid some significant value traps over our career in sell side and buy side equity research. For those interested in learning more about determining a company's value as it relates to ROIC, we recommend reading McKinsey & Company's "Valuation: Measuring and Managing the Value of Companies" or "The Value Sphere: The Corporate Executives' Handbook for Creating and Retaining Shareholder Wealth." We also find the newsletters produced by Michael Mauboussin, the Chief Investment Strategist at Legg Mason Capital Management, an excellent source of information as it relates to determining the value of companies.

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com

DISCLOSURES
Ascendere is in the business of providing equity research and related consulting services to investors and their advisors. The equity research it provides includes basic quantitative model portfolios and more detailed fundamental research with respect to individual stocks. In addition, the firm manages stock portfolios for itself and clients. Ascendere does not rate stocks on any scale, but does offer individual stock commentary and valuation opinions. With regard to Ascendere's portfolio strategies, "long" or "high-quality" baskets should generally be considered buys, unless otherwise noted. Stocks in our "short" or "low-quality" baskets should generally be considered sells, unless otherwise noted. While exceptions may occasionally occur, typically stocks in the high-quality basket are expected to outperform the S&P 500 over a month's time and stocks in the low-quality basket are expected to underperform. A more relevant benchmark would comprise of all stocks and ADRs that trade on major U.S. stock exchanges with a market cap above $2 billion. Ascendere adheres to professional standards and abides by codes of ethics that put the interests of clients ahead of its own. The following are specific disclosures made by Ascendere: 1) Ascendere may have a financial interest in the companies referred to in this report ("the Companies"). The research analyst covering the Companies and members of the analyst's immediate family have a financial interest in one or more of the Companies. 2) Ascendere generates revenue from research subscription revenue and portfolio management fees. At any given time it may be long or short any of the Companies. 3) Ascendere does not make a market in the securities of any of the Companies. 4) Ascendere has not received compensation from the Companies. 5) Ascendere has not managed or co-managed a public offering for any of the Companies. 6) Neither Ascendere nor any of its officers or any family member of the covering analyst serve as an officer, director or advisory board member of any of the Companies. 7) Neither Ascendere nor any of its officers or any family member of the covering analyst beneficially own 1% or more of any class of securities of any of the Companies. 8) The covering analyst certifies that this report accurately reflects such analyst's personal views.

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com

DISCLAIMERS
This report is intended for informational purposes only and does not constitute a recommendation, or an offer, to buy or sell any securities or related financial instruments. The report is not intended to be in furtherance of the specific investment objectives, financial situation, or particular needs of any individual recipient. The information contained herein accurately reflects the opinion of Ascendere at the time the report was released. The opinions of Ascendere are subject to change at any time without notice and without obligation or notification. The officers, affiliates or family members of Ascendere Associates may hold positions in the securities of the Companies. No warranty is made as to the accuracy of the information contained herein. This information is intended for the sole use of clients of Ascendere. Any other use, distribution or reproduction is strictly prohibited. Investing in stocks includes a high degree of risk, including the risk of total loss.

Ascendere Associates LLC J. Stephen Castellano

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October 22, 2010 steve@ascenderellc.com