CME

When identifying possible sell/short opportunities (torpedoes) The Applied Finance Group (AFG) starts by running a screen using its proprietary Sell Criteria variables starting with Economic Margin. Economic Margin is a  measure of corporate performance that identifies how profitable a company is by measuring how much the company earns above or below its cost of capital. In addition to corporate performance, AFG looks to identify those companies that are attractively priced using our valuation model. Lastly AFG evaluates how well companies run their business using its Management Quality score, eliminating companies that have management teams that destroy wealth.

The 9 firms listed below all meet AFG’s Sell Criteria. In addition, these companies all earn less than their cost of capital which means they earn a negative Economic Margin and only 3 (ERTS, MOLX, SWK) have a Z-Score (Altman Z-Score) that were not in the at-risk range. AFG has a track record of identifying winners and losers in the market.

If any of these firms are holdings in your portfolio, pay extra attention to these companies as they contain all of the characteristics of a bad investment and may be a potential torpedo lurking in your portfolio. AFG has proven successful since 1996 at identifying good companies as well as sell opportunities, providing a solid buy/sell spread.

Potential Torpedoes (S&P 500)

Economic Margin is a measure of economic profitability that identifies how much a company earns above or below its cost of capital. We analyzed all companies in the S&P500 Index based on their historical, current and forecasted Economic Margins to see which firms have the best average of past, present and future profitability. We identified the two most profitable and the two least profitable companies from each sector and have presented them in the table below. As a base of reference, the average firm in corporate America earns a 0 (zero) Economic Margin, or is a “break-even business”. Our research has shown that companies with consistently positive EMs that are also expected to increase their EMs in the future tend to outperfom firms with negative or declining EMs.
<!--[if gte mso 10]> Economic Margin is a corporate performance measure, which helps us identify well managed, wealth creating companies. Although not included in this post, we want to remind you that it is also important to understand the attractiveness of corporations' valuations to make sure we invest in great companies at great prices. (Here is an article by ValueExpectations.com explaining Applied Finance Group’s basic valuation concepts).

Note: Only companies in the S&P 500 were included.

S&P 500 Companies With The Best/Worst Average Profitability (Economic Margin)

Economic Margin (EM) Defined: A measure of corporate performance that captures off balance sheet items, by looking at how much a company is earning above or below their cost of capital. EM is expressed in a % or margin. The Economic Margin Framework™ is more than just a performance metric as it encompasses a valuation system that explicitly addresses the four main drivers of enterprise value: profitability, competition, growth and cost of capital. more EM details (PDF)

There are six companies in the S&P 500 currently trading at over $100 a share. Five out of those six are companies which have sales growth expectations priced-in to their current stock price that are lower than their historical five  year median sales growth.

Although AZO, CME, GOOG, ISRG and WPO are trading among the highest priced per share in the index, their expectations are reasonable enough to meet those sales numbers and add shareholder value. Regardless of whether the stock is trading at $10 or $100 it is not the current price that is important but the expectations that are embedded in that price.