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Corporations around the globe are constantly under pressure to meet sales expectations, which makes it very important when looking for investment opportunities to watch out for those companies that may be trying to pad their sales numbers in various ways, ie. Channel-stuffing (sending excess inventory to stores that will not be able to sell their products).

AFG's Earnings Quality variable helps investors identify companies that are likely to miss earnings by studying the components of their current earnings. Professor Richard Sloan pioneered this research, and concluded that companies whose earnings consists of a disproportionally high percentage of accounting accrual rather than cash flow are likely to suffer earnings reversals in the future.

Because companies with poor Earnings Quality are more likely to have negative earnings surprises, you may want to avoid firms with this characteristic. Our back-tests indicate that the EQ variable developed by The Applied Finance Group works well at eliminating firms likely to suffer earnings reversals in the future. The chart below depicts the annualized returns of companies based on their Earnings Quality Score. The returns shown are of Russell 1000 companies sorted into quintile buckets based on EQ Score relative to the Russell 1000 universe (blue bar). Companies that fall into the bottom quintile (poorest EQ rank) have underperformed the Russell 1000 universe by over 6% on an annualized basis since 1998.

Today we have put this variable to work for you, screening the Russell 1000 to identify the firms with the worst Earnings Quality (EQ) score that also rank poorly according to AFG's overall Investment Grade rankings which also take into account factors such as valuation attractiveness and momentum. (Note: Financial companies are not included in any EQ analysis as a good portion of their business is accrual based). In the section below you will find 15 companies from the Russell 1000 that have a high level of accruals (poor Earnings Quality) and also rank poorly according to AFG's overall Investment Grade, therefore these firms appear to be unattractive investment opportunities that should be avoided.

The 15 companies listed below have poor Earnings Quality based on AFG's Earnings Quality metric and also rank poorly according to AFG's overall Investment Grade. These companies contain many characteristics of a potential torpedo stock that could blow up a portfolio. We recommend reviewing these firms closely when considering adding or owning them in a client's portfolio.

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Often times heading into a new year, financial blogs and websites tend to provide lists of the best stocks to own in the coming year. We will take a slightly different approach and provide some companies to our readers that look overvalued and overall look like poor investment opportunities for 2012.

While we spend a significant amount of time providing lists of attractive investment opportunities for our readers, we also understand that it is just as important for professional investors to be able to avoid potential torpedoes in the market as it is to discover the next investment opportunity poised to hit a home run.

Today we will list 15 large cap companies from the S&P 500 that we deem to be potential torpedoes. These are companies that rank poorly according to important criteria developed by The Applied Finance Group (AFG), including Economic Margin, Management Quality (MQ) and Valuation Rank. These three criteria have proven through back-tests to identify stocks likely to underperform sector peers and benchmarks. If you own or are considering adding one of these companies to your client portfolios, you may want to take a closer look into these companies and reconsider whether or not they are worth adding/owning.

Three key metrics that are utilized to identify Sell ideas that have proven to underperform sector and index peers are Management Quality, Valuation and Economic Margin improvement. Three key questions listed below help us to identify potential torpedo stocks.

1. Management Quality - Is management able to create wealth for its shareholders?
2. Valuation - Is the company currently trading at a discount to its intrinsic value?
3. Economic Margin (true economic profitability) - Is the company improving its economic profitability (what it earns above its true cost of capital) at a greater rate than its sector peers?

If the answer for a specific company is no to all three of these important questions then you may want to think twice before adding that company to your portfolio as it possesses characteristics that have proven to produce poor returns. In the table below you will find 15 companies from the S&P 500 that look unattractive according to the criteria listed above.

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By: John Tamny, Toreador Research & Trading (Guest Contributor)

In an economically-themed speech last week in Kansas, President Obama revealed for all to see just how divorced he is from reality, and why his departure from the White House in 2013 is essential. It's not that we can't recover from another Obama term - that's the easy part - but that as a serious nation we can't have a president who possesses such unserious views.  Call it a pride thing. 

Though Obama acknowledged up front the certain wonders of free markets, he only threw out the initial bouquet to decry those same unfettered markets. As he put it, "the free market has never been a free license to take whatever you can from whomever you can," as though those who participate in the marketplace on the way to great fortune somehow took from others in doing so. Really?

When I read about the members of the Forbes 400, I'm made aware of extraordinarily driven individuals who not only worked very hard to achieve their fortunes, but who also worked very smart. In doing so, and as evidenced by their grand wealth, they've made the lives of millions much better.

To list but a few members of this most exclusive group, I find Michael Dell whose eponymous computer company has made the once elusive and expensive personal computer cheap and ubiquitous, and then Amazon's Jeff Bezos, whose online retail innovations have animated the PC. I see Patrick Soon-Shiong, whose pharmaceutical genius has made the scourge that is cancer more survivable, and then I see people like Michael Milken whose financial wizardry opened democratized access to capital for the kind of entrepreneurs just mentioned.

The skeptical may well argue that Obama was targeting the rich Americans whose fortunes were somewhat maintained by the bank and auto bailouts of three years ago, not to mention the profligate individuals who purchased homes they couldn't afford only to be saved on the backs of prudent Americans who didn't commit such egregious errors. As Obama put it himself back in 2008, "Part of why our debt crisis is so bad is that some folks are making reckless decisions - racking up big credit card bills by purchasing flat-screen TVs and other luxury goods that they know they can't afford."

There Obama would have a point, but then it was the political class of which he's a prominent member that made the ghastly decision not long ago to excuse the mistakes of rich and poor alike, all of this paid for by the taxpayers.  As Obama put it in explaining his support for TARP in 2008, "Today I fully support the efforts of Secretary Paulson and Federal Reserve chairman Bernanke.  What we're looking at right now is to provide the Treasury and the Fed with as broad authority as necessary to stabilize markets and maintain credit." 

Translated, it was when politicians like Obama led our retreat away from free markets that politicians (and presidential candidates in Obama's case) gave themselves "license" to take from others. As the word "free" in free markets makes plain, the very unregulated markets that our president mocks ensure that no one is coerced; instead consenting individuals choose to transact with those offering them the best deal. The greater the profit the greater the unmet need fulfilled, and the Forbes 400 is full of bright business types who removed a great deal of unease from the lives of their customers and clients.

But rather than embrace the certain achievements of the rich in our midst whose wealth mirrors our betterment and constantly rising standards of living, Obama last week resumed his call for increasing the tax penalty levied on those whose innovations serve us. Supposedly raising the price of work for the rich will strengthen the middle class, but apparently not understood by Obama is that most of the members of the Forbes 400 were once firmly part of the middle class; their path out of the middle a function of their past ability to access capital from the very 1 percenters whose income the president would like to take more of.

Missed by Obama is that to penalize the success of the rich with taxes is to reduce the amount of investable capital for tomorrow's entrepreneurs who aspire to join the 1 percent. After that, and considering the tautological reality that the U.S.'s economic success is the certain result of the individuals who comprise the top 1 percent, is it a good idea when the economy is struggling to put more weights on the men and women with the greatest economic skills? If the previous question is hard to understand, readers might ask if the NFL would be better off economically if tomorrow Roger Goodell decreed that Aaron Rodgers, Tom Brady and Ben Roethlisberger had to throw with their left hands.

Further on Obama argued that rebuilding the economy "will require American business leaders to understand that their obligations don't just end with their shareholders." Nice rhetoric if you're a community organizer, but very much beneath a president whose stated objective is to improve the economic outlook. To put it very simply, the only obligation business leaders have is to please shareholders precisely because without shareholders there are no companies and there are no jobs.

Apparently Obama missed the above memo as evidenced by easily the most frightening part of his speech in which he noted that, "Over the last few decades, huge advances in technology have allowed businesses to do more with less, and made it easier for them to set up shop and hire workers anywhere in the world....Steel mills that needed 1,000 employees are now able to do the same work with 100, so that layoffs were too often permanent, not just a temporary part of the business cycle....If you were a bank teller or a phone operator or a travel agent, you saw many in your profession replaced by ATMs or the Internet." Missed by our most economically illiterate of presidents is that the very definition of the productivity that attracts the investment necessary for company formation and job creation is the process whereby companies figure out how to produce more with less in the way of labor inputs.

After that, would President Obama prefer that U.S. business remain static, and free of innovation? Can he name one economically successful country in the history of the world that grew to be that way by virtue of shielding itself from technological advancement? The personal computer has arguably destroyed more jobs than any technology in the history of mankind, thus begging the question of whether Obama would prefer that it not exist.

At present Obama rightly decries the lack of opportunity within our limping economy, but rather than look in the very mirror that would reveal his policies to be the problem, he continues to blame his admittedly hopeless predecessor, and then when that doesn't work, he fingers the rich and their allegedly low rates of taxation as the source of our economic ills. As Nietzsche once said, "No one is such a liar as the indignant man."

What's funny and sad at the same time is that Obama doesn't realize how easy he has it. To understand true difficulty, it's worthwhile to consider Germany in the aftermath of World War II when, after losing a generation of human capital along with nearly its entire infrastructure, many Germans were reduced to living in caves. Having inherited this spectacular disaster that made the hand that Obama was dealt look positively grand, Ludwig von Erhard slashed spending and taxes, then pegged the country's currency to a gold-defined dollar. Within three years a once destroyed country could claim one of the most powerful economies in the world.

In Obama's case he too has had three years, yet the economy that he inherited is in many ways much worse today. Looked at through the von Erhard prism, Obama did the opposite on the policy front with predictably negative results.  In short, the economic ill health that Obama properly bemoans can be directly correlated with the policies he's foisted on all of us. Obama's policy failures are our unemployment lines, and because they are, it's essential that voters relieve him of his presidential duties.

About John Tamny:
Mr. Tamny is a senior economic advisor to Toreador Research & Trading, columnist for Forbes and editor of RealClearMarkets.com. Mr. Tamny frequently writes about the securities markets, along with tax, trade and monetary policy issues that impact those markets for a variety of publications including the Wall Street Journal, National Review and the Washington Times. He’s also a frequent guest on CNBC’s Kudlow & Co. along with the Fox Business Channel.

To gain access to our best stock picks and most extensive buy/sell lists, click here to sign up for our free weekly newsletter Investment Advisor Ideas.

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By: John Tamny, Toreador Research & Trading (Guest Contributor)

By now most readers are familiar with an exciting energy innovation called hydraulic fracturing, or the shortened word used to describe it, “fracking.” The energy extraction technique has led to major natural gas discoveries stateside, not to mention petroleum finds that have many Americans confident about easy, domestic oil access as far as the eye can see.

About energy exploration, it should be said up front that this column in no way objects to it occurring anywhere and everywhere. And while all energy subsidies – brown and green – should be abolished with great speed, to the extent that private investment exists to support the sourcing of energy, the federal government should get out of the way.

All that said, it says here that the excitement underlying fracking is overdone. Though all technological advances are something to embrace, for individuals to be exuberant about fracking amid a world awash in oil is the equivalent of Americans dancing in the streets over new techniques discovered for the easy manufacture of t-shirts.

That’s the case because contrary to the widely held belief that oil is scarce at the moment, the greater truth is that oil isn’t expensive as much as the dollar is cheap. Measured in the constant that is gold, an ounce of the yellow metal buys roughly the same amount of oil today as it did in 1971 when a barrel of oil traded for around $2.50. Far from an energy crisis rooted in a short supply of oil, we have at present a dollar crisis that is creating the false illusion of energy scarcity.

And with a weak dollar the driver of nominally high oil costs, much as occurred in the 1970s, there’s presently a rush of investment toward the oil patch. Evidence supporting the latter abounds, and includes $100,000 jobs in previously unknown locales such as Williston, ND, the opening of Mercedes car dealerships in long forgotten Pennsylvania towns, and myriad columns from commentators on the right celebrating “America’s energy economy.”

Though I find the word “bubble” a lazy one used by writers unwilling to take the time to understand the markets about which they write, suffice it to say that the energy exploration symptoms of our weak dollar point to some very stupid money chasing an oil illusion that will surely end in tears. Much as an overly strong dollar made oil nominally cheap in the late ‘90s on the way to dumb money funding long dead Internet concepts such as Webvan, theglobe.com and eToys, it’s apparent that the reverse is occurring today as dumb money – late to a dollar driven energy boom that began in 2001 – once again searches for simple profits in the energy sector.

For this alone we can expect some staggering investment errors lured into energy by the money illusion that will lead to substantial capital destruction over time. If it’s too good to be true it usually is, and right now success in the oil patch is too easy. Investors beware.

After that, while it should be said once again that investors should be free to place their capital wherever they desire, the modern rush to energy brings with it other negatives that should have an exuberant right wing very concerned. Indeed, the flight of capital toward the energy sector cheered on loudly by the right violates the basic economic views that have historically animated the more growth oriented side of the political divide.

First up is comparative advantage. Though David Ricardo would be on the Mr. Rushmore of most right-wing economic thinkers, his brilliance is ignored here. Economist Mark Perry has noted that the profit margins in energy are rather pedestrian, ranking 112th in the U.S. among industries. That the margins are so unimpressive speaks to the value of the U.S. becoming largely energy dependent. Rather than commit limited human, financial and physical capital to an economic discipline that profit margins deem prosaic, we should allow others to source the world’s abundant oil so that we can devote always limited resources to more profitable business concepts; our production elsewhere used to exchange for petroleum that we most definitely need.

Many on the right will say comparative advantage doesn’t apply to oil, that the U.S. has many oil-rich enemies who might cease selling it to us. The problem for those who take this position is that embargoes are a certain mirage. There’s no accounting for the final destination of any commodity, so assuming a wildly unrealistic scenario whereby some or all of the world’s energy producers choose to embargo us, the simple truth is that we’ll still consume their oil as though it bubbled up in North Dakota. Once any good reaches the markets its final destination can’t be controlled, and so long as we’re productive stateside, we’ll have the resources to exchange for oil.

Of course the false presumption of the use of oil as a “weapon” speaks to yet another problem with the U.S. becoming an energy economy: much of the world’s oil is controlled by governments. That is so because oil is immovable. North Dakota oil is North Dakota oil, and because it is, the fingerprints of greedy politicians will always be apparent.

Conversely, if politicians in California ever become too overbearing in terms of taxation and regulation, Google, Intel and eBay can simply move the human capital that drives the success of all three elsewhere. That’s not the case with oil. It bears repeating that it cannot be moved.

That it can’t helps to explain all the intrusive regulation of the energy sector that the right correctly decries. The problem here is that it’s not soon going to be lightened given oil’s static qualities in terms of location, thus begging the question why the right seeks more investment in that which politicians can so easily regulate, and as the excessive governmental responses to the BP/ExxonMobil spills of the past reveal in living color, punish.

The right also correctly loathe taxation, as does this column. If so, oil is yet again not the place to commit resources. Returning to oil’s immovable nature, because it is, politicians have an easy time taxing its profits. While Facebook is a concept of the mind that can migrate its human capital to the tax climate it deems best, Continental Resources cannot change the location of the Bakken oil field. And because it can’t, politicians will always have the upper hand when it comes to taxation.

Over the last ten years the price of oil has spiked thanks to a weak dollar, thus creating the illusion of scarcity despite abundant global supplies of what is a rather prosaic commodity. High prices of oil have attracted investment, along with a growing desire within the commentariat for the U.S. to take advantage of the oil boom to “create jobs” amid tough times for workers.

The thinking here is backwards. Unemployment is high precisely because a weak dollar either has investors in hiding, and then to some degree chasing an energy spike that is monetary in nature. Readers should be wary.

Indeed, a rush to oil is a flight of talent and capital to the basic, easily taxable and regulatable commercial concepts of yesterday. Worse, it violates arguably the most powerful economic idea ever conceived in comparative advantage. That energy is the hot sector at the moment should horrify us for it being a symptom of tragic dollar policy, and for the investors who’ve funded the flight to the oil patch, they should be rather leery. This rush to yesterday’s ideas, aided by a laudatory modern innovation in the form of hydraulic fracturing, promises to end badly.

About John Tamny:
Mr. Tamny is a senior economic advisor to Toreador Research & Trading, columnist for Forbes and editor of RealClearMarkets.com. Mr. Tamny frequently writes about the securities markets, along with tax, trade and monetary policy issues that impact those markets for a variety of publications including the Wall Street Journal, National Review and the Washington Times. He’s also a frequent guest on CNBC’s Kudlow & Co. along with the Fox Business Channel.

To gain access to our best stock picks and most extensive buy/sell lists, click here to sign up for our free weekly newsletter Investment Advisor Ideas.