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Best Stocks Since Obama’s Election – Including Freeport-McMoran C & G (NYSE:FCX) Cognizant Tech (NASDAQ:CTSH)
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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Sales Growth Expectations of S&P 500’s Top Performers – Including Cognizant Tech Sol. (NASDAQ:CTSH)
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
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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.
To stay updated on how other professional investor's currently view the market join our Market Forecast Project survey and be among the first to receive the results.
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Understanding Wealth Creation – Using AFG’s Wealth Creation Report Including Best Buy (NYSE:BBY) Cognizant Tech.
Investors who use The Applied Finance Group’s (AFG’s) research and suite of investment tools have the ability to easily understand a company’s true economic profitability, as well as if the company’s asset management policy is suitable to maximize that profitability.
A company that earns above its cost of capital (positive Economic Margins) and is growing its asset base is considered to be following a wealth-creating strategy. Backtests have proven these companies to be more likely to outperform those companies following a wealth-destroying strategy (negative Economic Margins and growing assets). Avoiding firms with management teams who try to grow a negative profitability business has helped our clients since 1996 avoid potential torpedoes in the market. AFG believes that if a firm is not profitable, it needs to divest losers and focus on its core competencies to get its profitability levels back on track and earn the right to grow, rather than throw more money at a losing business. After getting an understanding of how profitable a firm is and which direction the firm’s profitability is headed, investors must then understand how much a company is growing out its assets to take advantage of its current profitability or what to divest in order to fix its profitability.
Beyond having positive Economic Margins (EMs) and growing assets, investors want to see a company improve its EMs at a greater rate than its sector peers, as these companies have also proven to be more likely to outperform than companies with declining EMs. AFG’s Wealth Creation Report (WCR) allows you to visually analyze a company’s historical EM level, current EM and expected change in EM based on projections built out by AFG’s default valuation model, which takes into account the total cash flow a company delivers.
Below are a few examples of companies AFG considers to be following wealth-creating or wealth-destroying strategies, identified by using AFG’s Wealth Creation Report.
Best Buy: Consistent Wealth Creator
Amphenol Corp: Consistent Wealth Creator
Cognizent Technology Solutions: Consistent Wealth Creator
Southwest Airlines: Consistent Wealth Destroyer
Micron Technology: Consistent Wealth Destroyer
Electronic Arts: Growth at the expense of its Economic Margins (Wealth Destroyer)
AFG's Wealth Creation Report is a 3 part chart :
The first chart is a summary of a company’s economic performance over time, as well as insight into how analyst EPS forecasts project AFG’s default EMs over the next two years.
• EM – Productive Capital = (Cash Flow minus Capital Charge excluding Intangibles) divided by the
Inflation Adjusted Productive Capital.
• EM – Invested Capital = (Cash Flow minus Capital Charge including Intangibles) divided the by
Inflation Adjusted Productive Capital.
•Val Score = Ranked Percent To Target for the current calendar yr. where 100 is the most undervalued
and 0 is the most overvalued (ranked across all firms in database with forecasts for 4,000 firms).
• EM Chg = One year out forecast EM minus last reported fiscal year's EM. Invested Capital EM is used.
The second part of the chart is the Asset Growth chart allows additional insight not only the growth of a company, but how that company’s growth strategy has affected their economic performance.
• Assets – Steady Growth (1 Yr) = The real growth rate at which a firm can increase its capital base
given internally generated cash, while maintaining a constant capital structure.
• Assets – Actual Growth (1 Yr) = Real year over year change in Inflation Adjusted Invested Capital
achieved by the firm. Note: All actual growth is “actual”, i.e. 2007 growth represents growth from most
recent quarterly balance sheet.
This data can then be used to identify how the stock has performed in relation to the market place.
• Return Net Market = The company's cumulative total return relative to the cumulative market-weighted
average total return of the largest 2000 companies for the equivalent time period.
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Financially Healthy Stocks With Attractive Valuations
Value Expectations teaches professional investors how to make more informed investment decision evaluating stocks on the basis of corporate performance, valuation, management quality, earnings quality, and other proprietary variables. These variables inevitably help identify companies that are potential long-term investments while avoiding potential torpedoes. However, during the financial crisis, leverage and a week balance sheet played a significant part when investors evaluated a holding.
To help our institutional clients navigate the environment The Applied Finance Group (AFG) developed the risk analysis template specifically to model the healthiness of a company’s balance sheet. In addition to the risk analysis template we also developed a template that calculated an Altman Z-Score developed to identify companies that are most likely to go bankrupt.
As professional investors we often move on and like to forget the past concentrating on how to gain alpha in the future. However, not to forget the past we decided to post an update list in the S&P500 on companies that are financially healthy and are attractively priced using The Applied Finance Groups valuation model.
Provided below is a list of healthy Z-score companies within the S&P 500 that also look attractive based on The Applied Finance Group’s (AFG’s) investment criteria. All of the companies listed have an attractive valuation and are expected to improve their Economic Margins (AFG’s measure of what a company earns above its cost of capital) more than their sector peers. Companies expected to improve their Economic Margin’s (EMs) have proven to be more likely to outperform than companies with an expected decline in EMs.
Using AFG’s valuation model on AFGView.com, we identified a few firms that looked relatively attractive from a valuation perspective and had an Altman Z-Score above 2.99. Below is a list of those firms. Later we will look at firms that are expensive and have a Z-Score below 1.8.
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About The Altman Z-score - Z-score is a metric that gives insights into the likelihood of a firm going bankrupt in the next 2 years. The model was developed by Professor Edward I. Altman of the NYU’s Stern School of Business and first published in The Journal of FINANCE in September 1968. A common critique to this metric is that it was developed over 40 years ago and is no longer relevant.
In 2001, Professor Joseph D. Piotroski of The University of Chicago Graduate School of Business, published a paper called, Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers. Piotroski showed that value investors were rewarded by looking at a firm’s financial health and he showed that Z-score was a meaningful statistic.
The Altman Z-Score breaks down firms into 3 zones:
• >2.99 – Not Likely to Go Bankrupt
• 1.8 - 2.99 – Gray Area
• <1.8 – Likely to Go Bankrupt in the Next 2 Years
Related Tickers: "NYSE:PCP"
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Economic Competition: Competitive Advantage Period
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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S&P 500 - Which Are The Riskiest Companies?
By using The Applied Finance Group’s (AFG's) Risk Analysis, we have identified the top and bottom two firms in each sector (excluding the Financial sector) according to an overall risk score based on 9 variables (see more detail below). In addition to the risk analysis variables we also added another layer of analysis by evaluating the companies’ Earnings Quality (based on the concept of Accruals) and Altman Z-Score (identifies firms that are at risk of going bankrupt in the next 2 years).
Here is a list of the variables that are taken into account within this risk analysis:
Applied Finance Group’s Risk Analysis is designed to systematically calculate a stock’s risk score based on fundamental relationships between the Quarterly Income Statements and Balance Sheets. The template measures 9 factors to determine Risk: Changes in A/R, Changes in Inventories, Cash Flow vs. Operating Cash Flow, Fixed Payments vs. Pre-Tax Cash Flow, Leverage, Intangibles, Write-offs, Management Quality, and Valuation. Companies with lower scores have less risk. Companies in the Financial Sector were excluded due to their differences in financial statement structure.
1. Receivables to Sales - Delta – takes the difference in the median A/R to Sales ratio over the last 4 quarters vs. median 4 quarters before that.
2. Inventories to Sales - Delta – takes the difference in the median Inventories to Sales ratio over the last 4 quarters vs. median 4 quarters before that.
3. AFG’s Cash Flow-Oper. vs. Operating Cash Flow - AFG's Cash Flow-Oper. for a company is net cash that is generated by the continuing and discontinuing operations of the firm. We compare it to the company's Operating Cash Flow to assess its ability to pay its debt.
4. Fixed Payments vs. Pre-tax Payments Cash Flow – This ratio assesses the company’s ability to cover long-term obligations. If the fixed pmts are greater than 50% of the pre-tax payments cash flow, there is chance that this company may not be able to meet its obligations. Obligations less than 30% of cash flow are considered safe.
5. Leverage – Book leverage and Market leverage are analyzed to give us information about the company’s leverage position. Best score is given to the companies with Book Leverage lower than 60%, and negative score to these with Book Leverage higher than 60% and Market Leverage greater than 0.9*Book Leverage.
6. Intangibles as a Percentage of Total Assets – With this score we try to filter through and reward the companies that have grown organically, rather than through acquisitions. Our research has shown that on average companies tend to overpay for acquisitions and thus are rarely a profitable investment. Companies with Intangibles less than 20% of Total Assets get the best score.
7. Write-offs – Shows the number of years with significant write-offs over the last 5 years.
8. Management Quality – Measures a company’s EM+1 and LFY Asset Growth and there is empirical evidence that companies with positive EMs that are able to grow their business tend to outperform companies with negative EMs who continue to invest into unprofitable business.
9. Value Score – Measures a company’s attractiveness from valuation perspective.
Most/Least Risky Firms By Sector S&P 500 (excluding financials)
In Shape, and Looking Good...
In life, the most attractive people are in shape and have good looks, just look at Hollywood. The same is true the majority of the time in investing. The most attractive stocks have healthy financial statements and look good from a valuation standpoint.
The Altman Z-score is a metric that gives insights into the likelihood of a firm going bankrupt in the next 2 years. The model was developed by Professor Edward I. Altman of the NYU’s Stern School of Business and first published in The Journal of FINANCE in September 1968. A common critique to this metric is that it was developed over 40 years ago and is no longer relevant.
In 2001, Professor Joseph D. Piotroski of The University of Chicago Graduate School of Business, published a paper called, Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers. Piotroski showed that value investors were rewarded by looking at a firm’s financial health and he showed that Z-score was a meaningful statistic.
More recently, on December 5, 2008, Dr. Altman was called to testify before a House of Representatives Committee on the condition of U.S. Automakers. In his testimony, he noted that Bloomberg, Inc. reported, “that approximately 1,000 users of their system per day access the Altman Z-Score model.”
The Altman Z-Score breaks down firms into 3 zones:
• >2.99 – Not Likely to Go Bankrupt
• 1.8 - 2.99 – Gray Area
• <1.8 – Likely to Go Bankrupt in the Next 2 Years
Using AFGView.com, we screened for firms that looked relatively attractive from a valuation perspective and had an Altman Z-Score above 2.99. Below is a list of those firms. Later we will look at firms that are expensive and have a Z-Score below 1.8.
Sales Expectations for Companies with an Attractive Valuation and Healthy Balance Sheet
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