GPS

The flowchart below outlines The Applied Finance Group’s custom screening process which takes into account several factors to screen on as well as provides step by step process to end up with the highest quality investment ideas. In Step 1 of AFG’s custom screening process we identified companies that were trading at a discount to their intrinsic value as AFG’s valuation process is a key component in the screening process. Today we will combine the criteria of looking for cheap companies with companies expected to improve their economic profitability (Economic Margins) as well. Economic Margins are highly correlated with market values and can provide investors an edge in their stock selection process if they have an understanding of a company’s true economic profitability. Our daily examples will show that an increase in margins typically leads to market out performance, where a decline in margins leads to market under performance.

The month of February provided much optimism for the retail segment, as U.S. retailers posted their best monthly sales performance since just before the recession started in 2007. Three-quarters of the 28 retailers in the Thomson Reuters index beat expectations, with the index’s same store sales up 4% in February, compared with expectations for a 2.9% rise. It seems that people are not too busy tending to their budget to go out to splash $200 on a pair of jeans at Nordstrom (JWN), or a set of jewelry at Tiffany (TIF) to please the loved ones. After all, Valentine’s Day falls in the month of February. It seems, too, that teenagers did not want to be left behind with the spending spree, helping boost sales at Abercrombie & Fitch, American Eagle Outfitters and Aeropostale. While some were quick to point out a recovery in consumer spending, others were more cautious in assessing how much of a recovery has been priced in retail stocks. First, while the positive comps growth of most retailers is pleasing, it came as a result of easy comparisons, with the base period comps down 4.7%. Second, tax refund checks are either making its way to tax-payers’ mailboxes, or have already made its way to cash registers at the shopping malls. With refund checks being sent out as early as the end of January, it is safe to assume that some of these checks contribute to the comps growth. Therefore, the question that remains is, when comparison normalizes and tax refund fades, what is the sustainable growth for the country’s retailers?

Twice in 2009, ValueExpectations.com highlighted “Fidelity’s Low Priced Stock Fund”, an investment strategy that has been employed since 1989 by fund manager Joel Tillinghast. The theory behind this “low-price” strategy is that stocks within the small cap space tend to experience the most frequent mis-pricings and have the least amount of analyst coverage. Mr. Tillinghast created this strategy to take advantage of the numerous inefficiencies in small caps. They started out as a strategy to invest in stocks trading below $10; that limit has since been raised to $35 to widen the pool of investable stocks. Since the prior 2 stock lists that we previously provided have outperformed, we will once again provide our readers a list of 30 attractive stocks under $35.

With the biggest shopping season of the year just around the corner, we thought it would be timely to highlight some consumer sector companies that look attractive according to The Applied Finance Group’s (AFG’s) criteria for investment opportunity attractiveness, as they are in line to benefit from the upcoming seasonal spending patterns. The list of companies we have provided look the most attractive within the AFG consumer sector in terms of valuation attractiveness, economic performance, and overall investment attractiveness relative to their peers.

One of the companies that we feel particularly confident in is the retailer Kohl’s (KSS) which is currently a holding in The AFG 50, (a model portfolio of 50 large cap stocks designed to help Portfolio Managers save time, make more informed investment decisions, and outperform their benchmark). We are confident about Kohl’s competitiveness because they have a strong cash flow, strong execution, and have been outperforming their competition.

Going into this holiday season, consumers will most likely remain thrifty due to the overriding economic conditions, although their confidence levels have improved so far this year. They will search hard for values, being mindful of budget. We continue to believe Kohl’s will remain one of the most successful retailers in this country, as it strives to and succeeds in providing value to consumers with freshness and relevance of its merchandize.

The complete list of consumer stocks we have provided below, which includes the highlighted Kohl’s, are the companies AFG believes are the most likely to outperform. Companies that AFG identifies as having an attractive valuation, improving Economic Margins (AFG’s corporate performance metric) and an attractive investment opportunity signal have proven over time to outperform those companies with unattractive valuations, declining Economic Margins, and unattractive investment opportunity signal.

AFG Ticker Name AFG Sector Investment Opportunity 12 Attractive Consumer Companies (S&P 500) (NYSE:ARO) AEROPOSTALE INC Consumer Services Attractive (NASDAQ:ROST) ROSS STORES INC Consumer Services Attractive (NYSE:TJX) TJX COMPANIES INC THE Consumer Services Attractive (NASDAQ:DLTR) DOLLAR TREE INC Consumer Services Attractive (NYSE:KSS) KOHL'S CORP Consumer Services Attractive (NYSE:FDO) FAMILY DOLLAR STORES INC Consumer Services Attractive (NYSE:BIG) BIG LOTS INC Consumer Services Attractive (NYSE:GPS) GAP INC THE Consumer Services Attractive (NYSE:GME)  GAMESTOP CORP CL A Consumer Services Attractive (NYSE:WMT)  WAL-MART STORES INC Consumer Services Attractive (NYSE:BBY)  BEST BUY CO INC Consumer Services Attractive (NYSE:COH) COACH INC Consumer Non Durable Attractive

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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After reading a few articles highlighting attractive retail/apparel stocks, we have decided to analyze the companies mentioned in these two articles based on their attractiveness from a valuation standpoint using AFG’s valuation model.  We have examined the expectations for sales growth embedded in their current prices using AFG’s Value Expectation interface, as well as provided four companies that we find attractive in this retail/apparel space. The first four companies listed in the table are from an article in MSN Money by Catherine Holahan that mentions companies thriving in the recession (performed well in March), The second four are from an article from The Curious Investor (SeekingAlpha.com) that give the author's picks for companies ready to take advantage of a retail revival when consumer spending returns to a more normal level. The final four stocks are companies that we find the most attractive in the retail/apparel space.

When analyzing the sales expectations for these companies, 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.

 Retail/Apparel Companies

 

*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.