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The Applied Finance Group (AFG) has a disciplined approach for identifying companies that are expected to outperform and underperform the market by using proprietary metrics and measurements that have been tested and proven through time. Because AFG’s research is fundamentally derived, AFG’s quantitative analysis spans across growth and value stocks, all sectors, industries, and market caps with over 20,000 covered securities globally.

When searching for Large-Cap ideas, AFG’s Buy/Sell list is a good starting place as it has proven to create a significant spread in performance between companies that come up on AFG’s buy list and those on the sell list. Further focusing on companies based on AFG’s proprietary screening criteria (Economic Margin, valuation, quality of earnings, and management’s ability to create shareholder wealth) will save investors time in their research process. The result is a target group of stocks that can help you outperform as well as identify potential torpedoes to avoid in your portfolios.

Below is a list of attractive companies in the S&P 500 from each major AFG sector (excluding financials). It serves as a focus list of companies for investors to begin with as they meet AFG’s criteria to be an attractive opportunity. They are more likely to outperform their sector peers and the S&P 500, the benchmark that AFG’s clients most often compare themselves with.

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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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

About the AFG 50

The AFG 50 is an actively managed model portfolio of 50 stocks created by The Applied Finance Group, designed to outperform its benchmark, the S&P 500.

Launched on June 10, 2004 at AFG's inaugural client conference, the AFG 50 was created with the goal in mind of consistently beating the S&P 500. Through September 29, 2009, the AFG 50 has enjoyed the following performance in comparison to its benchmark:

                                                                             Price Returns
       

The AFG 50 has outperformed its benchmark 4 of the 5 year's since its inception.

Sector Neutrality

Weighted equally to the S&P 500, the AFG 50 remains sector neutral. Not making sector bet's can make it harder for portfolios to perform well in comparison to the S&P 500, however, by picking the best stocks in each sector, the AFG 50 has still managed to outperform it's benchmark.

The AFG 50 Portfolio has outperformed the S&P 500 by over 1400 basis points in the last two years with less than 15% turnover.  

With a model portfolio like the AFG 50, there are also many different benefits such as:

Consistent Methodology - Since it was created in 1999, AFG's framework has never changed, meaning all quantitative variables provided are derived through live data without bias.

Time Saving Research - Saving you time and effort by researching for you with frequent updated, the AFG 50 allows you to spend less time on daily due diligence activities and spend more time on harvesting new business.

Cost Efficient - The AFG 50 allows you to get the most out of your dollar. By using the AFG 50, you are provided with the research of an entire research team, which is less costly than hiring a personal analyst, let alone an entire analyst team.

Immediate Notification - Any time a change is made to the AFG 50, including new stocks, change of recommendation or adjustments to the model, every AFG 50 client will instantly be notified.

Complete Analyst Team - Backed by AFG's own team of analysts, the AFG 50 provides in-depth research reports on each update of the portfolio.  AFG's analyst team monitors each major economic sector with the intent of providing every AFG 50 client with actionable buy idea's backed by extensive research and due diligence.

Outsourced Research Team - The AFG 50 is meant to be used as an outsourced research team, providing AFG 50 clients with recommendations pushed by detailed models, company reports, live data updates and a back-up list for possible replacements within each sector.
Example Report

Example Report

Below is a sample of a recent report issued by our analyst team highlighting a new addition to the AFG 50 portfolio on Murphy Oil Corp.

If you are a professional investor and would like to view all 50 stocks in the portfolio Click Here to get a free trial.

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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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Listed below are the companies in the Energy & Extraction sector within the S&P 500 Index, ranked in order of valuation attractiveness. Currently, the Energy & Extraction sector has the highest median Value Score of all sectors according The Applied Finance Group’s April 2009 Monthly Market Review and looks to be trading at a significant discount relative to its historic valuation.

All Energy Companies (S&P 500) Ranked By Valuation Attractiveness

Energy Sector - Relative Valuation Chart

The graph above shows the median percentage upside for the Energy sector relative to the overall market across time. Values greater than 1 indicate the sector is more undervalued than the market, while values less than 1 indicate the opposite. The red line identifies the historical median value to provide a basis to understand valuation levels relative to historic norms. This example illustrates that the median Energy company is undervalued relative to the market currently and has been trading at a significant discount to its historic relative valuation, indicating a potentially attractive opportunity.