GILD

The Applied Finance Group (AFG), an independent equity research firm, would like to invite professional investors/money managers to participate in AFG’s Market Forecast Project (MFP). The MFP is a professional investor sentiment survey designed to help money managers make more informed investment decisions, enhance client communication and provide an edge in the portfolio construction process. The main focus of the MFP is to provide participants investment ideas, macro-economic sentiment and stock market predictions of a large and diverse group of investment professionals to see how other professional money managers in the industry view the market.

The AFG 50 is an actively managed buy list of 50 stocks, designed to outperform its benchmark (S&P 500) while remaining sector-neutral. The AFG 50 Portfolio serves as an outsourced research team, as our analysts monitor each major economic sector to provide our clients with actionable buy ideas backed by detailed models, reports, updates and a backup list for possible replacements within each sector. Anytime that there is a change made to the list, i.e., new stock, reiterated/change of add/drop recommendation or adjustments made to models, our clients are immediately notified via e-mail.

The AFG 50 was launched on June 10, 2004 at AFG’s inaugural client conference. Through December 31st, 2009, our clients have enjoyed the following performance:

The AFG 50 has outperformed the S&P 500 benchmark 5 out of 6 years with Cumulative Performance of over 1,500 bps.

• AFG50 and AFG100 are buy lists and results do not include management fees or transaction costs.

• AFG50 and AFG100 are re-balanced at end of each quarter to remain sector neutral vs. their respected benchmark, S&P500 and Russell 2000.

• Average Annual Turnover: AFG50 less than 20%, AFG100 less than 40%.

AFG 50:

• An actively managed buy list of 50 stocks, remaining sector-neutral.

• Long-only and targeting turnover of less than 40% annually.

Our Goals:

• To consistently beat the index our clients are most often measured against, the S&P 500.

• To serve as an outsourced research team, distributing relevant content to our clients on a timely basis.

• To provide consistent, actionable buy ideas in each major economic sector.

To stay updated on companies AFG believes are attractive investment opportunities register for ValueExpectations.com It's Fast and Free!

Here is a sample report from our AFG 50 buy list. The AFG 50 buy list provides institutional investment firms access to a devoted research team and investment process with the specific goal of consistently beating the S&P 500. The AFG 50 leverages our client’s investment process and enables them to focus on their core strengths. Below is a sample equity research report updating our thoughts on Gilead Sciences, Inc. (NASDAQ:GILD):

The Applied Finance Group

GILD Investment Summary: Company Description: A biopharmaceutical company which discovers, develops and commercializes therapeutics in areas of unmet need. Recommendation: Gilead Sciences, Inc. (GILD) is a biopharmaceutical company that discovers, develops and markets therapeutics that treat patients suffering from life-threatening infectious diseases, such as HIV, hepatitis B, and serious invasive fungal infections, as well as treatments for pulmonary and cardiovascular diseases. Additionally, GILD receives royalties for Tamiflu (marketed by Hoffmann-La Roche) for the treatment and prevention of influenza A and B, and Macugen (marketed by OSI Pharmaceuticals) for the treatment of age-related macular degeneration. GILD operates in North America, Europe and Australia, and partners with other drug manufacturers to distribute therapeutics in many underdeveloped countries around the world. GILD earns the highest margins in the biotech industry, helped by a robust HIV franchise (80% of total sales). GILD’s patents do not begin to expire until 2015, providing an attractive product profile, compared to its biotech peers whose key products will expire within the next several years. Our $64 target price suggests 49% upside. We initiate a Buy rating for GILD and will continue to hold it in the AFG50 portfolio as a core Health Care sector holding. Recent Events: • On August 10, GILD announced that it was closing two offices in Colorado and terminating 66 jobs there. About half of the employees were given the option to move to headquarters in California. • On September 23, GILD received conditional marketing approval from European regulators to market Cayston (formerly known as aztreonam), a treatment for chronic lung infection in cystic fibrosis patients whose dosing regimen calls for 3x / day for 28 days. Cayston will be launched in some EU countries in early 2010. • On September 25, the European Medicines Agency (EMEA) approved the use of Tamiflu on infants under the age of six months for the treatment of the H1N1 swine flu. The World Health Organization stressed the importance of early use of antivirals like Tamiflu at the onset of symptoms.   Click here to download and view the  entire 10 page report on Gilead Sciences, Inc.

Professional Money Managers, click here to register for a free trial of our AFG 50 Buy List.

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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).

Rank within Sector Ticker Name Sector Valuation Signal Top 10 S&P 500 CEO's  (NYSE:MA)  MASTERCARD INC CL A Consumer Services Attractive (NASDAQ:GILD)  GILEAD SCIENCES INC Health Attractive (NYSE:STZ) CONSTELLATION BRANDS INC Consumer Non Durable Attractive (NYSE:LO) LORILLARD INC Consumer Non Durable Attractive (NYSE:MON) MONSANTO CO Basic Material Fair (NASDAQ:CHRW)  C.H. ROBINSON WORLDWIDE Transportation Fair (NASDAQ:MSFT) MICROSOFT CORP Technology Fair (NYSE:FII)  FEDERATED INVESTORS B Financials Unattractive (NASDAQ:AMZN)  AMAZON.COM INC Consumer Services Unattractive (NYSE:ECL) ECOLAB INC Consumer Non Durable Unattractive

 

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

With a major week of earnings right around the corner, we thought it would be useful to our readers to provide an analysis of the companies set to report in the first half of next week. This analysis contains a breakdown of each company's default recommendation according to AFG's Buy/Sell criteria, a look at their valuation attractiveness, and a look at the direction their Economic Margin's are expected to head in the upcoming year. The three companies that look the most attractive based on these criteria are Pfizer, Advanced Micro Devices and Boston Scientific.

A company's Economic Margin (EM) is a measurement of a their true earnings above or below their cost of capital. EM also corrects distortions caused by accounting policies to give a more accurate assessment of a company's real value. It is important to understand the direction a company's EM's are heading because, by knowing this, one can get a complete assessment of how profitable a company can be in the future. The EM Framework addresses profitability, competition, growth and cost of capital. When factoring in each of these variables, investors can fully assess a company's value. 

Below is the list of companies reporting earnings in the first half of the upcoming week along with a closer look at Boston Scientific:

 According to the chart below, BSX's intrinsic value is above its current stock price, which leads us to believe that Boston Scientific is undervalued right now. 

 According to the Wealth Creation chart below, BSX has shown a positive Economic Margin and is forecasted to improve that margin in the upcoming year.

Source: Www.EconomicMargin.com 

AFG's Buy/Sell criteria factor in Economic Margin, Management Quality, and AFG's Valuation Metric. In order to determine Management Quality, AFG scores management on their growth decisions in accordance with the company’s ability to either create or destroy wealth. AFG's Valuation Metric measures a company's Percent to Target (the 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.

AFG's default valuation is a good place to start because it is a simple metric that gives a more accurate outlook on a company's value while correcting distortions.

 

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AFG’s Intrinsic Value Chart identifies how far a stock’s intrinsic value (target price assuming immediate decay) deviates from its trading range, which helps you recognize potentially mispriced stocks and pursue long and short opportunities.

• The blue bars represent the high and low trading range for a stock for 1 year.
• The red dotted line represents AFG’s historical Intrinsic Value through time.
• When the red line (Intrinsic Value) is above the blue bars (trading range), the company looks to be undervalued.
• When the red line (Intrinsic Value) is below the blue bars (trading range), the company looks to be overvalued.

AFG’s Intrinsic Value Chart also contains a company’s Value Score (ranked valuation attractiveness), Economic Margin Change (expected increase/decrease in economic profitability), and Accuracy score (how well AFG’s default valuation has tracked the company).

Wealth Creation Report: displays a company’s Economic Margins (what a company earns above or below its cost of capital) through time as well as a projection of their expected future levels. The second graph shows how a company has grown their assets over time and also contains a projection of how they will grow their assets next year. AFG’s view on wealth creation starts by looking for profitable companies that are also growing their assets to make the most of that profitability.

Investment Insights from your peers, Professional Investors - The Applied Finance Group would like to invite professional investors to join AFG’s Market Forecast Project so you can better understand what your peers currently think about the market and cultivate the “wisdom of Crowds” into actionable investment ideas and themes. 
Click here to learn more

 

 

 

On Monday we highlighted several companies from our buy/sell list that represented investment ideas for all types of investors, which included Small and Large Cap stocks as well as Growth and Value stocks. Since Value Expectations tends to provide Large Cap Value Stocks for potential Buy ideas, earlier this week we decided it would be helpful to also highlight some small cap stocks we like from the Russell 2000. Now, moving on to the Growth investor, we will focus on companies we classify as growth stocks and find attractive within the S&P 500 (excluding Financials). By definition, AFG classifies growth stocks as companies with a Market Value/Invested Capital (MV/IC) in the top half of their sector.

 

In the table below are 10 growth stocks that we find attractive based on AFG’s valuation model, and are ranked neutral or higher based on AFG’s default recommendation.

 

Attractive Growth Companies - S&P 500 (excluding Financials)

 

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 Growth Universe - Companies in the AFG universe, which have MV/IC in the top 50% of the universe and have EPS estimates.

Market Value/Invested Capital (MV/IC) - The firm's average total equity, debt and other obligations divided by net invested capital.
 

Every year Fortune releases a list of the 40 best companies to invest in now to retire on. This long-term portfolio is designed to protect your hard-earned nest-egg as you approach retirement.

Last year Fortune’s portfolio of 40 best stocks to retire on returned -23.07% from 6-20-08 to 6-16-09, relative to the -30.8% returned by the S&P500 during the same time period. This year they are replacing 23 stocks to form the new portfolio.

Provided below are the 40 stocks recommended by Fortune as the best stocks to retire on in 2009 and our outlook of these companies from a valuation perspective based on The Applied Finance Group’s valuation model.

 Fortune's 40 Best Stocks to Retire On - 2009

Related Stock Article:
Is Apple a Buy Hold or Sell?, Click Here to View

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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Bloomberg provides a score for companies within the S&P 500 based on an average of all analyst ratings from the street. Below is a table highlighting companies with the best analyst ratings, largest increase in rating, highest price targets, and worst analyst ratings and the valuation attractiveness of each of these companies based on The Applied Finance Group’s (AFG) valuation model.

Companies within each of these groups are ranked from most attractive from a valuation perspective to the least attractive. VE.com will actively track the performance of these recommendations and see how they stack up to the analyst recommendations in each group. AFGview.com, AFG’s professional investor website allows you to compare any company using their rating versus the consensus ratings of the sell side. If you are interested in an analysis on a specific company, contact afgsales@afgltd.com.

 

Best/Worst Analyst Rated Companies (Bloomberg)

 

AFG's 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.

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)

As a new administration takes office, investors will be looking for companies that will benefit most from Obama taking office. Which stocks will your “Obama Portfolio” consist of? Will you load up on infrastructure, health-care, alternative-energy, or green companies? If Obama’s big plans are carried out, these are a few areas that may see a direct benefit. Karim Bardeesy from The Big Money put together a list of stocks they feel will benefit from the new administration and are comparing their “Obama Portfolio” to one created by Jim Cramer. Here we will look at both portfolios and compare their sales growth expectations to see which of these firms will be more likely to out-perform. We will re-visit at a later date to see which “Obama Portfolio” will have provided the better return.

 

 The Big Money's "Obama Portfolio" and Each Company's Sales Expectations

*denotes less than 5 years historical sales numbers, ** = 2 years *** = 3 years

 

Jim Cramer's "Obama Portfolio" and Each Company's Sales Expectations

 

VE Sales Growth calculated for these companies on 1-21-09