KFT

When managing clients' money, it is just as important for professional investors to be able to avoid potential torpedoes in the market, as it is to discover the next attractive investment opportunity poised to hit a return home run. The Applied Finance Group (AFG) has proven through its Buy-Sell list returns that it does a good job of both identifying winners in the market as well as avoiding potential torpedoes. The backtest results below display the performance of companies that we have identified as buys, sells and holds since 1998. As you can see, by using AFG's Economic Margin framework and valuation techniques there is a significant spread achieved between those companies that we identify as buys and those identified as sells. (Ranked Strong Buy, Buy, Hold, Sell, Strong Sell) Three key metrics that are utilized in AFG Buy/Sell lists that have achieved the performance displayed above are Management Quality, Valuation and Economic Margin improvement. Three key questions listed below help us to identify potential torpedo stocks.

Investors involved in the equity markets often pay close attention to which stocks the prominent fund managers in the market are buying and selling every quarter when 13F filings begin to roll in. These reports provide insight into how the brightest investing minds and most successful money managers are currently investing their money and shed light on any big bets being made by these "gurus". Today we will highlight the stocks these "Gurus" have either recently added to their portfolios as new holdings or stocks that they have recently increased their position in the last quarter and rate them using the Economic Margin Valuation model. Specifically, we will be taking the pros picks and giving them letter grades (A, B, C, D, F) based on our valuation model. In addition, we will provide a Grade Point Average for each of the experts list of top holdings along with the largest increased positions.

The Dogs of the Dow is a very simple investment strategy that has proven to outperform the overall Dow over the long term. Two benefits of this strategy are that it is very simple to implement and will save money on trading/transaction costs as it is a long-term strategy with zero turnover during the year. Here are the two simple rules to employ this strategy. • Buy the top 10 stocks in the Dow Jones industrial average with the highest dividend yield. • Repeat this process at the beginning of each year, selling the companies that no longer remain in the top ten of highest yielding DOW companies. After taking the kinds of losses that occurred over the last 2 years, investors experiencing the “snake bit” (risk aversion) effect are less likely to gamble or exhibit risky behavior, and it is no surprise that dividend-paying stocks have been gaining increased popularity amongst the investment community and have performed quite well over the last year. Investors looking for a steady profit stream and a way to offset losses caused by fluctuations of stock prices have begun to seek refuge in consistent dividend paying companies. This strategy works well to gain exposure to some solid dividend paying companies and can be put into action with low transaction costs and low maintenance.

In a previous post back in September, ValueExpectations.com provided an analysis of the main holdings from Berkshire Hathaway and how each company was viewed according to The Applied Finance Group’s (AFG’s) valuation model and Economic margin methodology. The 29 top holdings of Berkshire were divided into 3 buckets (Attractive, Fairly Valued and Unattractive) based on how each company ranked according to key AFG criteria including valuation. Thus far each bucket of companies has performed just as expected.

Warren Buffett’s Berkshire Hathaway Inc., Kraft Foods Inc.’s (KFT) largest shareholder, recently indicated he would vote against Kraft’s proposal to issue 370 million shares to finance its bid for British candy maker Cadbury (CBY).

The current offer on the table is $16.5 billion in cash and stock to purchase Cadbury, which KFT’s management team believes is a smart strategic move to build a global powerhouse in snacks, confectionery, and quick meals, as well as to gain an increased exposure to emerging markets. KFT also believes that the combination of the 2 companies would allow it to achieve cost savings of $625 million annually.

Since news surfaced of KFT’s offer to buy CBY, The Applied Finance Group has pointed out that the deal would hurt Kraft's shareholders, as we believed the purchase price was too high. Berkshire’s thoughts on this deal appear to be in-line with ours, being that they refuse to approve the issuance of shares to fund this deal, unless it will not hurt KFT shareholders.

The expectations for what CBY would have to deliver to justify the proposed purchase price by KFT are very lofty and unrealistic to achieve. Kraft has made many promises about this acquisition and claims to be a disciplined buyer, but even if they achieve many of their savings goals and increase their exposure to emerging markets, it would still be very difficult to do enough to justify the price tag for Cadbury, thus hurting KFT’s shareholders (We stated in our first article). The market also seemed to agree with our thoughts on the initial deal as KFT’s shares underperformed by approximately 8% in the week after the deal was proposed.

From Cadbury’s standpoint, we disagree with their CFO who claimed that KFT’s initial offer was too low. Instead, we showed that CBY should take the money and run since its share price is being supported by the hopes that this deal will be completed. It is hard to believe that CBY’s share price will not drop if KFT removes their bid from the table.

As news of Berkshire's opposition to the currently proposed deal has had time to set in, it seems as if no deal would be the best deal for Kraft at this point. The market appears to agree with this logic, as shares of KFT outperformed the S&P 500 today by 458 bps, and CBY underperformed the S&P 500 by 403 bps, signaling that its share price has been inflated due to the hope of this deal being completed "as is."

The bottom line is that we believe that Kraft should focus on improving its existing operations to maximize shareholder value, rather than overpaying for Cadbury to "buy" growth. Soon after this deal was announced and well before the Wizard of Omaha resisted Kraft’s motion to issue new shares to finance its bid for CBY, AFG delivered valuable insights to show that this deal made no sense for the shareholders of Kraft.

Visit us often, and read next month's Wall St. Journal here at ValueExpectations.com!

image courtesy of BusinessWeek

Today Cadbury's CFO articulated why he felt Kraft's bid for Cadbury was insufficient and why he felt the company is still undervalued. Here is our ValueExpectations analysis when Kraft made their offer public. As we said then, If we were Cadbury's we would take a cue from The Steve Miller Band, and "take the money and run". If Kraft removes their bid does anyone believe that Cadbury's price will not drop?

Click Here to view the interview on CNBC with the Andrew Bonfield CFO of Cadbury's

Click Here to view ValueExpectations analysis of Kraft's offer to buy Cadbury's

The Oracle of Omaha Warren Buffett is generally viewed as the most respected and successful investor in history, and many of our value-oriented readers follow the movements and purchases of Buffett rather closely and for good reason. Berkshire Hathaway, a conglomerate holding company, which Buffett built from a textile company into a major corporation, has averaged a 20.3% compounded annual gain in per-share book value from 1965-2008. There is no doubt about the success Buffett has achieved over the years, and there has even been a recent study done that shows an investor could have earned over 14% returns a year had they purchased each Buffett stock, a month after his investment company disclosed ownership.

We thought it would be an interesting story to show how Buffett’s holdings would rank according to The Applied Finance Group’s (AFG’s) valuation model and Economic Margin Methodology. The companies we believe look the most attractive and that investors should pay the most attention to when searching for long investment opportunities are the companies that have both an attractive default AFG valuation and are expected to improve their Economic Margins at a greater rate than their sector peers.

AFG's track record of identifying winners and losers has proven that companies AFG identifies as undervalued are more likely to outperform, than those AFG ranks as overvalued, and the same holds true for companies with expected improvements in EMs vs. expected declines. The Economic Margin methodology adjusts for common distortions in GAAP accounting practices and helps investors to understand the true economic profitability a company earns above its cost of capital. By understanding the true economic profitability a company earns and by gaining a firm grasp on the expectations embedded in security prices, investors can come to a more refined intrinsic value for a company and thus put themselves in a better position to outperform.

Below is a list of Berkshire Hathaway’s current holdings (excluding Financials) ranked by valuation attractiveness, and followed by expected change in economic margins.

Rank within Sector Ticker Name Sector Valuation Signal EM Change Signal Berkshire Hathaway's Holdings (ex. Financials) (NYSE:SNY) SANOFI-AVENTIS ADS Health Attractive Positive (NYSE:WMT) WAL-MART STORES INC Consumer Services Attractive Positive (NYSE:UNP) UNION PACIFIC CORP Transportation Attractive Positive (NYSE:BNI)  BURLINGTON NTH SANTA FE Transportation Attractive Positive (NYSE:GSK) GLAXOSMITHKLINE PLC Health Attractive Positive (NYSE:BDX)  BECTON, DICKINSON & CO Health Attractive Positive (NYSE:NLC) NALCO HOLDING CO Basic Material Attractive Positive (NYSE:NRG)  NRG ENERGY INC Utilities Attractive Negative (NYSE:COP)  CONOCOPHILLIPS Energy and Extraction Attractive Negative (NYSE:NSC) NORFOLK SOUTHERN CORP Transportation Attractive Negative (NYSE:JNJ) JOHNSON & JOHNSON Health Attractive Negative (NYSE:PG) PROCTER & GAMBLE CO THE Consumer Non Durable Attractive Negative (NYSE:LOW)  LOWE'S COMPANIES INC Consumer Services Attractive Negative (NYSE:KFT) KRAFT FOODS INC CL A Consumer Non Durable Fairly Valued Positive (NYSE:KO) COCA-COLA CO Consumer Non Durable Fairly Valued Negative (NASDAQ:COST) COSTCO WHOLESALE CORP Consumer Services Fairly Valued Negative (NYSE:HD)  HOME DEPOT INC Consumer Services Fairly Valued Negative (NYSE:NKE)  NIKE INC CL B Consumer Non Durable Fairly Valued Negative (NYSE:CEG) CONSTELLATION ENERGY GRP Utilities Unattractive Positive (NYSE:WPO)  WASHINGTON POST CO Consumer Services Unattractive Positive (NYSE:IRM) IRON MOUNTAIN INC Consumer Services Unattractive Positive (NYSE:USG)  USG CORP Capital Goods Unattractive Positive (NYSE:KMX)  CARMAX INC Consumer Services Unattractive Positive (NYSE:GE) GENERAL ELECTRIC CO Capital Goods Unattractive Negative (NYSE:UPS)  UNITED PARCEL SERVICE B Transportation Unattractive Negative (NYSE:ETN)  EATON CORP Capital Goods Unattractive Negative (NYSE:IR) INGERSOLL-RAND PLC Capital Goods Unattractive Negative (NYSE:IR) WABCO HOLDINGS INC Consumer Durable Unattractive Negative (NYSE:GCI) GANNETT CO INC Consumer Services Unattractive Negative

Other Popular Articles: 

S&P 500 Expectations and Market Analysis 

Odds of a double dip of the economy

What Drives Market Prices? The Valuation vs. Momentum Dichotomy  

 

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.

Keeping an eye on the big movers in the market does not help investors determine which stocks are poised to continue their upward or downward movement. To help our devoted readers identify the movers that still look fundamentally sound and those to walk away from, ValueExpectations.com has scored each of the top 10 Hot and Cold stocks of the month based on Valuation Attractiveness and Economic Margin Change.

If an investor should consider adding any of these stocks as a holding for a portfolio, one should look for companies with attractive valuations and expected improvements in a company’s Economic Margin (EM) which essentially is a measure of a company’s true economic profitability. As an additional level of analysis, we also recommend understanding the embedded expectations that are priced into each of these stocks.

AFG’s Valuation techniques and understanding of economic profitability have proven to identify mispriced securities in the market and help clients take advantage of mispriced securities. Accurately assessing a company’s profitability and understanding how to answer key questions such as… What is the cash flow generated by the company’s operations? How much capital is required? What are the opportunity costs of this capital? This robust process is what sets AFG’s corporate performance metric Economic Margin (EM) apart from other Value Based Metrics such as an IRR calculation, a CFIRR or a RONA Economic Profit approach.

It is not surprising to see the list of best performers dominated by Tech stocks as professional investors in our last month’s sentiment poll identified Technology as the most attractive sector to bet on in the upcoming months and companies like DOW and EK on their respective best and worst lists as they both have been discussed recently on VE.com. Dow was recently noted as one of the most attractive stocks within AFG’s Basic Materials sector (ranked 2nd most attractive sector amongst professional investors) in mid-august. Eastman Kodak (EK) is just one example of a torpedo AFG’s clients and ValueExpectations.com readers have avoided due to regularly being on AFG lists of stocks to avoid and also a model of poor Earnings Quality (high accruals) one way AFG filters out companies likely to underperform, and more likely to encounter a negative earnings surprise. EK has consistently had a poor EQ score according to AFG’s measure of accruals and continues to be ranked amongst the worst in its sector in Earnings Quality.

Rank within Sector September Returns Ticker Name Sector Valuation Signal EM Change Signal S&P 500 Best Returns In September (ex. Financials)  (NYSE:DYN) DYNEGY INC A Energy and Extraction Attractive Positive 24.73% (NYSE:DOW)  DOW CHEMICAL CO THE Basic Material Attractive Positive 27.32% (NYSE:PCS) METROPCS COMMUNICATIONS Technology Attractive Negative 24.61% (NYSE:CNX) CONSOL ENERGY INC Energy and Extraction Unattractive Positive 24.43% (NYSE:ODP)  OFFICE DEPOT INC Consumer Services Unattractive Positive 25.46% (NYSE:THC) TENET HEALTHCARE CORP Health Unattractive Positive 25.97% (NASDAQ:SNDK) SANDISK CORP Technology Unattractive Positive 29.71% (NYSE:AMD) ADVANCED MICRO DEVICES Technology Unattractive Positive 34.12% (NASDAQ:CIEN) CIENA CORP Technology Unattractive Negative 28.40% (NASDAQ:WYNN) WYNN RESORTS LTD Consumer Services Unattractive Negative 32.62% S&P 500 Worst Returns In September (ex. Financials)  (NYSE:FDO)  FAMILY DOLLAR STORES INC Consumer Services Attractive Positive -13.57% (NYSE:BSX) BOSTON SCIENTIFIC CORP Health Attractive Positive -5.51% (NYSE:MHP)  MCGRAW-HILL CO INC Consumer Services Attractive Negative -27.30% (NYSE:AEE)  AMEREN CORP Utilities Attractive Negative -6.11% (NYSE:MON)  MONSANTO CO Basic Material Fair Positive -6.16% (NYSE:KFT) KRAFT FOODS INC CL A Consumer Non Durable Fair Positive -6.02% (NYSE:DHI) D.R. HORTON INC Capital Goods Unattractive Positive -7.59% (NYSE:PHM)  PULTE HOMES Capital Goods Unattractive Positive -6.34% (NYSE:IRM)  IRON MOUNTAIN INC Consumer Services Unattractive Positive -6.27% (NYSE:EK)  EASTMAN KODAK CO Consumer Durable Unattractive Negative -11.74%

 

KFT & CBY - Good Thing Kraft Mac N Cheese Does Not Taste This Bad!

Kraft Foods Inc (KFT), the world’s second largest food company and the largest in North America, unveiled a surprising bid for Cadbury Plc (CBY) over the Labor Day weekend. For each Cadbury Plc share, Kraft Foods proposed to buy for 300 pence in cash and 0.2589 new Kraft Foods share, for a total value of 745 pence. The entire share capital of Cadbury Plc is valued at £10.2 billion or approximately $16.8 billion (based on share prices and exchange rates on September 4, 2009). So far, Cadbury has turned down the offer.

Kraft management branded the proposed acquisition as the company’s strategic move to build a global powerhouse in snacks, confectionery, and quick meals. Specifically, Kraft believes combining KFT&CBY can be justified by the following value propositions:

1. The combined company could target long-term organic revenue growth in excess of 5% and sustainable long-term EPS growth of 9 to 11%, whereas Kraft targets long-term organic revenue growth of 4% and EPS growth of 7 to 9% on a standalone basis.

2. The higher long-term growth rates in revenues and bottom lines will be driven by revenue synergies and $625 million identified annual cost savings.

3. Cadbury is highly complementary to Kraft’s geographical footprint and will increase developing markets’ contribution to Kraft’s net revenue from about 20% to about 25%.

Kraft management has been banging the familiar synergy/strategy drum hard regarding the significance of the acquisition, and claims itself a disciplined buyer. While increasing exposure to developing markets does sound appealing and increasing top line growth by 1% on a large revenue base is worthy of applause, we are not sure those promises justify the price tag. Based on the proposed price of 745 pence per ordinary share or approximately $50 per ADR, CBY needs to deliver top line growth of 10% and EBITDA margins of 27% each year from 2010 to 2014 to justify the purchase price. Historically, CBY’s organic top line growth has been in the range of 4-6% and its EBITDA margins have declined from 22% in 2004 (peak) to 15% in 2008 (trough). It doesn’t take a brain surgeon to conclude, it will be very hard for CBY to achieve those lofty operational assumptions in the future to deserve the purchase price. If we boldly assume all the projected $625 million annual savings will come from Cadbury and be realized, CBY’s standalone EBITDA margin will increase by approximately 8%, still falling short of the implied 27% margin, based on its profitability track record from 2006 to 2008 (17%, 16%, and 15% respectively each year). In other words, even if the annual cost savings assumptions are realized, it is likely that Kraft is still overpaying for the projected cash flows CBY can bring to the table.  Needless to say, as with many deals spurred by enthusiastic I-Banker cheerleaders, Kraft may overestimate its ability to achieve the operational excellence required to justify its own assumptions of the transaction.

Turning to Kraft Foods. On a standalone basis, if Kraft is able to deliver annualized top line growth of 4%, grow EPS at the high end of its targeted 7-9% range, and achieve higher asset efficiency via productivity gains as management has been promising, its shares could be worth as much as $32, rather attractive relative to their current trading levels. It seems logical for us to suggest that Kraft should focus on improving its existing operations to maximize shareholder value, rather than overpaying for Cadbury to achieve non-substantial incremental growth. The market seems to agree with us as well, given since the announcement KFT has under-performed the S&P 500 by nearly 8%. In addition, Kraft will likely use $8 billion new debt to finance about half of the purchase, increasing its leverage to a higher level amid continuous economic uncertainties. While we appreciate KFT management’s confidence in the credit market and the overall economic environment, we are skeptical of the wisdom in pursuing the Cadbury acquisition at this moment. Needless to say, most companies in corporate America are tirelessly deleveraging. Management has insisted there is no threat to its existing investment-grade credit rating. Sadly most people purchased tech stocks up to the crash, and continued to buy real estate as the bottom fell out. In today’s environment, we turn to the wise Chinese saying, “Hope for the best, but prepare for the worst”. Leveraging up in this environment to purchase pricey assets does not seem very wise.

Consumer Staple stocks such as Kraft and Cadbury generally have stable cash flows but limited growth opportunities. In the past five years, the median annualized sales growth for Staple companies in the S&P500 was 6.4%, vs. 9.5% for the overall S&P500. However, just to achieve that 6.4% growth, companies in the sector have consistently turned to acquisitions to drive top line figures. In fact, from 2003 to 2007, the median % of intangible assets / invested capital for the S&P500 Consumer Staple companies has grown from 19.2% to 27.2%. Aside from creating enormous fees for I-Bankers, and building mega empires for corporate managers, how much wealth has such activity generated? In order to measure such wealth creation, we like to look at a metric we call Market Value to Invested Capital, or MVIC. MVIC tells us how much the market is willing to pay for a pile of assets. It is a multiple of total market value relative to the economic investment a company’s management team has put in place. When this figure is rising, a firm’s assets are becoming more valuable; when it is falling, a firm’s assets are becoming less valuable; when it stays the same, a firm’s assets are not changing in value. While Staple companies were spending billions on goodwill from acquisitions, the market yawned, as over this same time period, the median MVIC (Market Value/Net Invested Capital) for the sector remained largely flat at 2. In contrast, the S&P500 median MVIC increased from 1.65 to 1.91 in the same 4-year period, or close to a 20% improvement. It seems the market was not rewarding Staple companies with higher multiples, probably as the assets to the sector were not any more valuable than they were prior to the growth generated by the sector’s significant acquisition activity. Note that from 2007 to 2008, MVIC dropped for the market as a whole due to the financial crisis. Staple companies having a safe haven reputation experienced a smaller decline. Graph 1 below show these various trends.

In short, we don’t believe Kraft Foods should pursue the acquisition of Cadbury at the price it has offered. Instead, Kraft should maximize its shareholder value by delivering the organic growth and profitability targets management has laid out from its existing business. Cadbury shareholders, however, should take the money and run. While it has been the modus operandi for the Consumer Staple companies to achieve extra growth through acquisitions (shown in graph 2 below), it is more often than not a-much ado about nothing. As we have shown time and time again (Good and Bad Management Strategies), growth only matters when it generates increasing economic profits. Growth for the sake of growth typically leads to distracted management teams and underperforming stock prices. If Kraft carries out the acquisition, its management may be yet another management team that seems to have forgotten the core principles that create value – investing in projects that earn a return above the cost of capital. At its offered price, CBY is likely a negative NPV project and KFT should find a way to either lower its bid or walk away from the deal.

Graph 1

• - Staples are Consumer Staples companies in the S&P500.

- The medians below are for respective sectors in the AFG universe. 

Graph 2

 

 Other Popular Articles:

S&P 500 Expectations and Market Analysis 

Odds of a double dip of the economy

What Drives Market Prices? The Valuation vs. Momentum Dichotomy

With Berkshire Hathaway’s annual meeting just behind us, we thought it would be interesting to provide an analysis of the Oracle of Omaha’s companies (ex. Financials) to give you a better idea of their valuation attractiveness. The companies that rank highest on valuation should be more likely to outperform going forward and could represent an attractive investment opportunity.

Year to date Mr. Buffet’s portfolio has delivered an average return of 5.18% compared to the 12.93% delivered by the S&P 500 Index (as of May 8, 2009). In the future we will measure the performance of each of the three groups of stocks we now label as Attractive, Fairly Valued, and Unattractive, in order to see what type of spreads are achieved between them.

 

Berkshire Hathaway's Holdings (ex. Financials) Ranked By Valuation Attractiveness

If you want to learn more about AFG's Valuation methodology, click here.

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)

Recently Berkshire Hathaway released a letter to its shareholders, which outlined last year’s activities and provided insights on their outlook going forward with an overview of the company's major holdings.  Below is a list of Berkshire's major holdings (excluding Financials) and ValueExpectations.com’s recommendations for these companies.

We will revisit this later in the year to see how ValueExpectations.com's recommendations fared.

 

Applied Finance Group's quantitative process is centered on their proprietary Economic Margin Framework. The core of AFG’s quantitative process starts with evaluating a company's corporate performance and the expected improvement on a relative basis, assessing the valuation attractiveness of the company, and determining if a firm is following a wealth creating or wealth destroying strategy.

A brief description of those variables is below:

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.
Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to it's peers.
Management Quality – Assess management’s ability to make wealth creating decisions.

The Applied Finance Group (AFG) works with some of the most well respected investment firms in the U.S. to help them develop quantitative screening processes to identify a better fishing pond of companies to choose from for their portfolio holdings. However, picking winning investment opportunities isn’t the only value add AFG provides clients. They also develop quantitative strategies to quickly identify possible torpedoes lurking in your client or prospective client’s portfolio.

AFG’s quantitative process is centered on their proprietary Economic Margin Framework. The core of AFG’s quantitative process starts with evaluating corporate performance and the expected improvement relative to their peers, evaluating the valuation attractiveness of the company, and determining if a firm is following a wealth creating or wealth destroying strategy.

A brief description of those variables are below:

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.

Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to their peers.

Management Quality – Access management’s ability to make wealth creating decisions.

When identifying torpedoes AFG looks for companies with the least valuation upside compared to their sector peers, below sector median expected Economic Margin change, and a management quality score that reflects a management team following a wealth destroying strategy.

These 16 S&P 500 companies are potential torpedoes that could be lurking in your portfolio. These companies all possess characteristics that make for a bad investment opportunity. If you own one of these companies and would like a more in-depth explanation of why they are considered a potential torpedo, please email support@afgltd.com.

 

S&P 500 Potential Torpedoes

*AFG’s Value Expectation interface 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 above table displays the implied future sales growth of these mining companies assuming their EBITDA margins and Asset turnovers stay at the 5 year median levels.

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

According to Forbes.com, Cramer and a few other financial blog-sites the following qualities are usually found in stocks that do well in economic downturns of extended time periods.

• Consumer necessities
• Ability to pay a dividend
• Ability to add employees as other firms cut back
• Productivity increases as market goes down
• Healthcare stocks
• Legacy Companies – high quality company with long business history
• Involved in Military
• Oil industry
• Infrastructure
• Companies that sell used goods
• Generic products
• Overseas exposure

The following companies all have one or more of the above qualities to help them survive and perform well in an economic downturn. This table provides the implied 5 year sales growth priced-in to the stock to justify its current price along with the 5 year median achieved sales growth. Compare the revenue growth priced-in to what the company has been able to deliver in the past 5 years to see if the expectations are reasonable enough for the company to meet. Companies with reasonable expectations compared to what they have achieved are the most likely companies on the list to out-perform.

Stocks with Recession Resistant Qualities & Sales Growth Expectations