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With 2009 winding down and a full year in the books for the current administration, we have provided a breakdown of the best performing stocks since President Obama was sworn in as President on November 4, 2008.

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Using The Applied Finance Group's (AFG's) Value Expectations interface we have provided an analysis of the expectations embedded in the stock prices of some of the top performers in the S&P 500 year to date (excluding financials) to see which companies have the lowest expectations for sales growth (VE Sales Growth) relative to what the company has been able to deliver historically (5 Year Median Sales Growth).

AFG’s Value Expectations interface provides clients a platform to better understand economic profitability, and at the same time understand the performance a company must deliver to justify its current stock price. By understanding the embedded expectations a company must deliver to justify their current trading price, clients can develop a “hurdle rate” to quickly determine if the company’s expectations are rich or low. Take, for example, the typical company during the tech bubble: the expectations that were priced into the average tech stock far exceeded what it could realistically deliver. For this reason, AFG identified the technology sector as overvalued, as well as potential torpedoes such as Cisco, whose expectations were unrealistically high.

By gaining a better understanding of the embedded expectations built in to security prices, relative to what a company has delivered historically, can provide insight into the Sales Growth, EBITDA Margin, and Asset Turnover a company must deliver in the future to justify its current trading price. In many circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued.

The top performers of the S&P 500 listed below are ranked based on valuation attractiveness using The Applied Finance Group’s valuation model. You would like to look for companies with attractive valuations and modest expectations for revenue growth relative to what the company has been able to achieve over the past five years when looking for potential investment opportunities as these types of companies have proven through time to outperform firms with the opposite characteristics.

If you would like to view some of the favorite long and short investment ideas provided by professional investors click here to view the results for AFG's Market Forecast Project.

Sales Growth Expectations of S&P 500 Top Performers of 2009

Source: EconomicMargin.com

AFG's Valuation Metric – Measures the percent to target (deviation between a stock’s current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model (modified discounted cash flow model).

Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.

Management Quality – Assesses management’s ability to make wealth creating decisions.

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The Applied Finance Group (AFG) is an independent equity research provider that has partnered with CEO Magazine in recent years to give investors insight into which CEOs do the best job of creating value for its shareholders; after all, that is what they are hired for. The AFG/CEO Wealth Creation Index, which relies upon AFG’s corporate performance metric Economic Margin (EM), provides a better understanding of wealth creation than traditional accounting measures such as EPS and ROC. The link below will take you to the complete list of rankings of CEOs from S&P 500 companies that have held their current position for at least 3 years, based on their wealth creation abilities. Topping the rankings in 2009 is MasterCard’s Robert W. Selander, up from third place last year. Both Selander and runner-up Federated Investors’ J. Christopher Donahue run very high EM companies (24.5 percent and 20.6 percent three-year averages, respectively). Interestingly, both have been able to improve in a bad economy.

As a further layer of analysis, we have taken the companies of the top 10 CEOs and ranked them based on Valuation Attractiveness to give insights into which companies on the list look the most attractive as potential investment opportunities. Even good companies with strong leadership do not always make good investments, because it depends on what you pay for them. The companies on the list that look unattractive from a valuation standpoint are the companies we recommend reviewing in greater detail before you consider adding to any portfolio.

Since 1996, through back-tests and model portfolio results, AFG has proven to be successful at identifying winners and losers in the market by utilizing its Economic Margin methodology (understanding a company’s true economic profitability), and valuation techniques as seen in the Buy/Sell spread (provided below).

AFG Recommendation Performance
9/1998 – 5/2009
Annualized Returns

Source: AFGView client databases from 9/1998 – 5/2009
Universe size: 4,000 to 5,500 firms

Understanding the amount of accruals a company has on its books and the quality of its reported earnings is especially important during earnings season, as poor earnings quality companies are more likely to have negative earnings surprises and underperform as a result. With so many companies reporting earnings this week, we wanted to share an analysis of their earnings quality based on The Applied Finance Group’s Earnings Quality score. AFG’s Earnings Quality variable is based on the concept of accruals and is an important indicator, which helps to differentiate between companies with poor and high quality of reported earnings. Watch out for firms with poor EQ score – make sure they are not trying to pad their sales numbers through channel stuffing, for example.

*Source: www.afgview.com

Two ways to approach accruals:

1. Cash Flow Statement
•Difference between Net Income and Cash Flow

2. Balance Sheet
•Change in Net Operating Assets from Period t-1 to t
•Net Operating Asset equals Total Assets Less Cash, Less Non-Debt Liabilities (excl. Minority Interest)
• Our studies show that the Balance Sheet approach is superior to the Cash Flow Statement approach.
• We found the Balance Sheet approach is also easier to expand to international companies.
• Low Accrual companies outperform high accrual companies
 

 Here is a look at how well the Earnings Quality variable works when you split top half vs. bottom half in each sector/style universe.

Source: AFGView client databases from 9/1998 - 5/2009   Universe size: 4,000 to 5,500 firms

Here is a look at an example of a poor Earnings Quality company that has a negative earning surprise and thus underperforms.

Eastman Kodak

• Other Liabilities declined in Q308, leading to high accruals – change in licensing agreement required immediate recognition of deferred revenue.
• Eastman Kodak (EK) subsequently missed earnings in Q408.
• EK’s stock dropped 29% on January 28th, when Q408 earnings were announced.
• EK has underperformed the S&P500 by almost 70% since January 28th.
 

source: www.economicmargin.com

The Applied Finance Group’s (AFG’s) Earnings Quality variable is an important indicator of companies that may be more likely to have negative earnings surprises and underperform due to high amounts of accruals. With many firms under pressure to meet sales expectations in the current environment, it is important to watch out for those firms that may be trying to pad their sales numbers, ie. Channel stuffing (sending excess inventory to stores that cannot sell their products).

The EQ score ranges from 1 to 100, 1 being the best EQ score resulting from the lowest accruals, and 100 being the worst EQ score indicating the highest accruals. Because high EQ score companies (bad Earnings Quality) are more likely to have negative earnings surprises, you may want to avoid these firms. Our back-test indicates that the EQ variable works well as an exclusionary variable coupled with AFG’s valuation model.

We screened the S&P500 to identify those firms with the worst Earnings Quality (EQ), which may be possible torpedoes. The Chart Below displays the 14 firms along with their EQ scores and our valuation analysis.

Earnings Quality: Accruals

•An accrual is the difference between Cash Flow and Net Income.

•Net Income = Cash Flow + Accruals

•Low Accrual companies outperform high accrual companies

Two ways to approach accruals:

1. Cash Flow Statement
•Difference between Net Income and Cash Flow

2. Balance Sheet
•Change in Net Operating Assets from Period t-1 to t
•Net Operating Asset equals Total Assets Less Cash, Less Non-Debt Liabilities (excl. Minority Interest)

-Our studies show that the Balance Sheet approach is superior to the Cash Flow Statement approach.

-We found the Balance Sheet approach is also easier to expand to international companies.

 14 Worst Earnings Quality Firms

Here is a look at how well the Earnings Quality variable works when you split top half vs. bottom half in each sector/style.

Source: AFGView client databases from 9/1998 - 5/2009   Universe size: 4,000 to 5,500 firms

Here is a look at an example of a poor Earnings Quality company that has a negative earning surprise and thus underperforms.

Eastman Kodak

If you like this article, you might be interested in stocks that fit our Buy Reccomendations: Click here to read

A brief description of some other AFG's insights:

AFG's Valuation Metric – Measures the percent to target (deviation between a stock’s current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model (modified discounted cash flow model).

Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.

Management Quality – Assesses management’s ability to make wealth creating decisions.
AFG's Value Universe - Companies in the AFG universe, which have MV/IC at the bottom 50% of the universe and have EPS estimates.

Traditional Discounted Cash Flow (DCF) models have been been underutilized in equity analysis over the years primarily because of the assumptions one has to sign off on. We will concentrate on just two of the major issues we have with traditional DCF models, the lack of ability to deal with competition and the perpetuity assumption embedded in a DCF model. These assumptions lead to irrational calculations of intrinsic value and force analysts to make compromising decisions in their model building efforts.

AFG uses a modified DCF model that accurately addresses the competitive nature of the business while also dealing with the perpetuity issue through our Economic Margin decay or competitive advantage period.

The four factors that affect AFG’s Competitive Advantage Period (CAP) are;

Profitability – High Profit leads to increased competition and a higher decay rate
Variability – Higher volatility leads to less predictability and a higher decay rate
Trend – AFG gives the benefit of the doubt to an upward trend which leads to a lower decay rate
Invested Capital – Large Invested Capital creates barriers to entry and leads to lower decay rate

The Decay Rate is the rate at which the Economic Margins™ will diminish over time due to competition, market conditions and limited investment opportunities. Higher decay rates translate into shorter competitive advantage periods, while lower decay rates translate into longer competitive advantage periods.

The Decay Rate profile is downward sloping to the right, which means that Economic Margins™ over time diminish to zero. This does not mean that the company will not have earnings, but instead the company will have an Economic Margin™ of zero, which indicates there are no excess profits after the investors are paid and the depreciating assets are replaced.When selecting securities, companies that are maintaining a high level of economic profitability or growing their profits rapidly are attractive from an investment standpoint. However, the more profitable a firm is the more likely other companies will attempt compete away excess returns.

To illustrate this, one has to look no further than Dell Computer. Dell Computer had Economic Margins™ hovering around 40% (top 5% of all companies) in 1997 and 1998, but soon every major firm was announcing that they were going to build computers to order. Why? Because they saw the huge profits that Dell was making. The result is that Dell's Economic Margin™ for 1999 was around 25%, a decline of 37.5% in just one year. The remaining factors are relatively straight-forward, in that volatile returns are worth less than consistent returns, companies with an increasing Economic Margins™ are worth more than a company in decline, and large companies have a natural barrier to entry, thus a lower decay rate.

Theory: Excess return gets competed away

Fact: In 1997, the median top decile Economic Margin (EM) firm = 17.4%. 10 years later, that same group of companies had a median EM of 6.5%. On the other hand, the bottom decile had an EM of -12.2%, 10 years later that same group had a median EM of -1.0%.

Current Top Decile Economic Margin Companies (S&P 500 ex. financials)

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In March, Jim Jubak of MSN Money released a list of stocks that he believed should be stocks that you should pay attention to in the upcoming months/quarters as potentially attractive investment opportunities. ValueExpectations.com set out to answer the question, which stocks on Jim’s watch list look attractive according to AFG’s valuation model and should be on your watch list?

Provided in the table below are Jubak’s watch list companies and how they fare from a valuation perspective using The Applied Finance Group’s Value Score variable which ranks the valuation attractiveness of each company based on the discrepancy between the company’s current trading price and AFG’s target price.

Jubak's Watch List Companies (Ranked by Valuation Attractiveness)

Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to its peers.

AFG's Value Score - A score which represents the ranked percent to target (deviation between stock’s current trading price and AFG’s current default target price) or attractiveness (upside) relative to the universe. A Value Score of 100 is the most undervalued and 0 is the most overvalued company in the universe.

Tickersense.com has recently published an article highlighting 15 companies that have been the leaders of the market since the low on November 20, 2008. Made up mostly of Tech stocks (8 of 15), this list of companies has been responsible for about half of the total change of the S&P500 since November 20, and the author believes it is a good place to start if you are “looking for leadership”. Below is a table highlighting the price performance of 12 of the 15 companies (Financials were excluded as well as WYE and SGP due to takeovers).

A second table provides an analysis of the valuation attractiveness of these companies as well as the market expectations for sales growth implied in the stock’s current price using AFG’s Value Expectations interface. Measuring the spread between a company’s VE sales growth expectations and what it has historically delivered should give you a good idea of which companies have the best chance of meeting or exceeding those expectations, and thus are more likely to outperform.

 Performance From November 20, 2008 to Yesterday's Close

Valuation Attractiveness & Implied Sales Growth Expectations

*AFG’s Value Expectations allows us to understand the Sales Growth, EBITDA Margin, and Asset Turnover a company has to deliver in the future to justify its current trading price. In theory and in normal circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The table displays the implied future Sales Growth of the list of companies assuming their EBITDA Margins and Asset Turnovers stay at the 5 year median levels.

Jon C. Ogg of Wall St. 24/7 provided a list of companies that were upgraded or downgraded on Thursday April 2, 2009 by analysts from some major firms. We took his list of companies (excluding Financials) and provided some insight on how we think each company is valued by using The Applied Finance Group’s (AFG’s) valuation model, and provided the embedded expectations for sales growth implied in the stock’s current price using AFG’s Value Expectations interface. Measuring the spread between a company’s VE sales growth expectations and what it has historically delivered will give you a good idea of which companies have the best chance of meeting or exceeding those expectations, and thus are more likely to outperform.

Companies With Analyst Revisions (April 2, 2009)

*AFG’s Value Expectation allows us to understand the imbedded Sales Growth, EBITDA Margins, and Asset Turnovers a company has to deliver in the future to justify its current trading price. In theory and in normal circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The table displays the implied future sales growth of companies assuming their EBITDA margins and Asset turnovers stay at the 5 year median levels.

With the first quarter of 2009 winding down, ValueExpectations.com has compiled a list of the best and worst performing stocks thus far in 2009 (excluding financials). It is not surprising for us to see two companies on the top performer list (S and MYL) that also appeared on our list at the end of January, or three bottom performing companies (ODP, TXT and MTW) still remaining on the bottom performer list over a month and a half later. We published an article in early February highlighting the top and bottom performers for the month of January and posed the question “Is the January Effect effective?”

Top 10 S&P 500 Companies (YTD 2009)

Bottom 10 S&P 500 Companies (YTD 2009)

Our conclusion: Looking at the YTD returns for the companies in our January effect article's top and bottom lists, we notice that there is a huge spread. January’s top performers have earned an average return of 4.66% YTD compared to January’s bottom performers’ average YTD return of -57.15%. This pretty compelling spread suggests that the January effect may be something investors want to pay closer attention to next year and it may even be helpful for the remainder of 2009.

*AFG’s Value Expectation allows us to understand the imbedded Sales Growth, EBITDA Margins, and Asset Turnover a company has to deliver in the future to justify its current trading price. In theory and in normal circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The table displays the implied future sales growth of companies assuming their EBITDA margins and Asset turnover stay constant at the company's historical 5 year median.

Below is Value Expectations’ analysis of the companies in the S&P 500 with the 10 best and 10 worst returns for 2009 YTD (excluding financial companies). Comparing the sales growth expectations priced in (VE sales growth) to what the company has delivered in sales growth historically allows us to see which firms have the most reasonable sales growth expectations implied by their current trading prices and thus are more likely to outperform. Will the companies with the best returns be able to maintain their momentum for the remainder of 2009? Will the companies with the worst returns be able to turn things around? We will track the S&P500 winners and losers in the year ahead and provide you with regular updates.

10 Worst S&P 500 Companies 2009 YTD

10 Best S&P 500 Companies 2009 YTD

*data as of close Feb. 20, 2009

*AFG’s Value Expectation allows us to understand the imbedded Sales Growth, EBITDA Margins, and Asset Turnovers a company has to deliver in the future to justify its current trading price. In theory and in normal circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The table displays the implied future sales growth of companies assuming their EBITDA margins and Asset turnovers stay at the 5 year median levels.

Mike Burdi of Applied Finance Group and Drew Morris of Great Numbers recently published a ranking of S&P 500 companies in CEO Magazine Using AFG's Wealth Creation Index. This measure of ranking CEO’s has been gaining traction and receiving publicity in national publications. Below are a few links to articles that have recently been published discussing our methods and results of identifying the biggest wealth creators and destroyers amongst the CEO’s of the nation’s largest companies.

An article written by Pittsburgh Post Gazette highlighting CEO Of Federated

An article from Planebuzz.com highlighting Southwest Airlines CEO

An article explaining the rankings with a link to the article by Directors Daily

An article explaining Economic Margin by New Jersey Star Ledger

The entire article posted on RealClearMarkets.com

The top and bottom CEO's from the rankings below:

Top 5 Companies based on CEO Rank along with Sales Growth Expectations

Bottom 5 Companies based on CEO Rank along with Sales Growth Expectations

Performance Rankings of the Top 50 and Bottom 50 Wealth Creating CEO's

The tech sector has been taking a pretty bad beating the past few months but according to Bill Luby of SeekingAlpha.com, The 4 Horsemen of Tech (RIMM, AAPL, GOOG, AMZN) will be the most likely companies in the sector to make the strongest comeback when the tech sector makes a comeback. Here is a list of many of the big names in tech and the implied sales growth expectations priced-in to justify their current price. The companies with low sales growth expectations priced-in (VE Sales Growth) compared to what they have been able to deliver in sales growth (5 Year Median Sales Growth) are the companies we believe have the best chance of making a strong comeback with the sector.

According to historical valuations the tech sector appears to be trading at a discount compared to historical valuations such as the Tech Bubble.

Big Tech Companies and Sales Growth Expectations

According to Forbes.com, Cramer and a few other financial blog-sites the following qualities are usually found in stocks that do well in economic downturns of extended time periods.

• Consumer necessities
• Ability to pay a dividend
• Ability to add employees as other firms cut back
• Productivity increases as market goes down
• Healthcare stocks
• Legacy Companies – high quality company with long business history
• Involved in Military
• Oil industry
• Infrastructure
• Companies that sell used goods
• Generic products
• Overseas exposure

The following companies all have one or more of the above qualities to help them survive and perform well in an economic downturn. This table provides the implied 5 year sales growth priced-in to the stock to justify its current price along with the 5 year median achieved sales growth. Compare the revenue growth priced-in to what the company has been able to deliver in the past 5 years to see if the expectations are reasonable enough for the company to meet. Companies with reasonable expectations compared to what they have achieved are the most likely companies on the list to out-perform.

Stocks with Recession Resistant Qualities & Sales Growth Expectations

Today we look at a recent article in CEO magazine by Mike Burdi of The Applied Finance Group (AFG) and Drew Morris using AFG’s Wealth Creation Index to rank the top wealth creating and wealth destroying CEO’s within the S&P 500. After comparing the top 5 on each list by using AFG’s valuation techniques and comparing the sales growth expectations built-in to their current price (VE Sales Growth) with what the companies have achieved in the last five years (5 Year Median Sales Growth), it is easy to see that good companies do not always make good investments. AFG’s Value Score measures the stock’s attractiveness relative to the universe based on AFG’s Intrinsic Value Target Price. The score is ranked from 1-100 with 1 being the most overvalued and 100 being the most undervalued stock in the universe. VE sales growth captures the sales growth expectations priced-in to the stock to justify the current price.
Although the top 5 are well run companies, that does not automatically qualify them to be good investments. Depending on what the market has priced-in, and how likely the company can deliver that performance determines whether the company is a good investment or not. Many companies that have been beaten up and even those with wealth destroying CEO’s may be a good investment if very low expectations are priced-in and you feel the company can exceed their expectations.

Top 5 Wealth Creating CEO’s

*denotes company has only 3 years historical sales growth

Top 5 Wealth Destroying CEO’s

VE Sales Growth was calculated for these companies on 12/14/08