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It is very important to understand a company’s management strategy and management’s ability to create wealth for its shareholders. By using The Applied Finance Group’s (AFG’s) Management Quality score investors have the ability to grade management’s ability to make wealth creating decisions and eliminate wealth destroying firms from your list of constituents. AFG’s Management Quality variable is used as an exclusionary variable to get rid of companies which continue to grow their businesses when they are not profitable (generating negative Economic Margin or negative EM, which is AFG’s way of understanding a firm’s economic profitability). When business units are unproductive and destroying wealth, management teams should not be looking to grow that business unit and concentrate on the parts of their company that have been creating wealth. Instead, the corporation needs to fix the broken parts of its business first by divesting losers and work on improving profitability to earn the right to expand. The best strategy AFG or any investor likes to see is a very profitable business (generating positive EMs) that grows its assets to maximize its profitability.

The companies listed below have been following a wealth destroying strategy and also look unattractive according to AFG’s valuation model and other key criteria AFG evaluates when considering the attractiveness of potential investment opportunities. These companies should be looked at with caution when considering these companies as additions to your clients portfolio as they contain many of the characteristics that AFG has proven to cause a company to be more likely to underperform the market and its sector peers.

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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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It is very important to understand a company’s management strategy and management’s ability to create wealth for its shareholders. By using The Applied Finance Group’s (AFG’s) Management Quality score you have the ability to grade management’s ability to make wealth creating decisions and eliminate wealth destroying firms from your list of constituents. AFG’s Management Quality variable is used as an exclusionary variable to get rid of companies which continue to grow their businesses when they are not even profitable (generating negative Economic Margin or negative EM, which is AFG’s way of understanding a firm’s economic profitability). When business units are unproductive and destroying wealth, management teams should not be looking to grow that business unit and concentrate on the parts of their company that have been creating wealth. Instead, the corporation needs to fix the broken parts of its business first by divesting losers and work on improving profitability to earn the right to expand. The best strategy AFG or any investor likes to see is a very profitable business (generating positive EMs) that grows its assets to maximize its profitability.

The companies listed below (which include CAT & AMAT) have been following a wealth destroying strategy by growing their assets as their EMs have been declining which is reflected in their stock prices as none of these companies have been able to create any value for their shareholders over the last year. Along with managements inability to create shareholder wealth, these firms also look unattractive according to AFG’s valuation model and other key criteria AFG evaluates when considering the attractiveness of potential investment opportunities. These companies must stop growing their assets or divest some losers and focus on improving their EM’s before these firms will begin to see sustainable improvements in their stocks price and begin to add wealth to their shareholders. The expected change in the level of a company’s EMs has proven through back-tests to be highly correlated with the subsequent performance of its stock price. The 2 company examples below show the levels of each companies EMs through time as well as their asset growth. CAT and AMAT have continued to grow their assets as their EMs have declined and that strategy is reflected in their falling stock prices.

Management Competence Factors

• Have there been any changes in the executive management team?

• Has the company had any significant write-offs or poor earnings quality?

• Has the company recently made any significant acquisitions and, if so, what are the strategic implications and costs?

• How is the company spending any excess cash?

• What did we learn from the company’s most recent earnings call and what was the tone of analyst questions?

Management Quality Score Insights:

• Measures a company’s EM+1 and LFY Asset Growth.

• Companies that have positive EMs should grow their business while firms with negative EMs should focus on profitability and earn the right to grow.

• Un-bias quantitative way to analyze a company

• Holds management teams accountable for unprofitable growth

Below are examples of AFG's Wealth Creation Reports of CAT & AMAT that show deteriorating EMs while continuing to grow their assets and the subsequent poor performance over the past 1 year.

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