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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.

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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

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.

In March, Jim Jubak of MSN Money released a list of stocks that he believed should be stocks that you should pay attention to in the upcoming months/quarters as potentially attractive investment opportunities. ValueExpectations.com set out to answer the question, which stocks on Jim’s watch list look attractive according to AFG’s valuation model and should be on your watch list?

Provided in the table below are Jubak’s watch list companies and how they fare from a valuation perspective using The Applied Finance Group’s Value Score variable which ranks the valuation attractiveness of each company based on the discrepancy between the company’s current trading price and AFG’s target price.

Jubak's Watch List Companies (Ranked by Valuation Attractiveness)

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.

Fortune released a list of 40 companies in June 2008 that they labeled as the 40 best stocks to retire on. Although ValueExpectations.com’s research is focused on long-term investing, we believe reviewing companies on a ongoing basis helps to avoid potential pitfalls with bad investments and allows one to take advantage of companies that might be mispriced. For this reason we have ranked all companies in the Fortune 40 portfolio based on Valuation Attractiveness.

Good companies don’t always make good investments! If you believe this is a list of quality companies then that is a wonderful start. But understanding what you are paying for those companies is equally important. Few would argue that Mercedes Benz produces an excellent engineered vehicle and a quality product. However, if that Mercedes Benz cost $1,000,000, it may be a great vehicle, but not necessarily a good price.

As a review of the performance of this list since release, Fortune’s portfolio has returned an average of -28.64% since its release which is about 6.3% spread above what the S&P 500 delivered on average during the same time period. Although this portfolio did outperform the S&P 500, had you invested in these 40 companies in equal parts on the date of release, your $100,000 retirement nest egg would now be worth somewhere around $70,000.

Fortune 40 Companies To Retire On

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

Below is a summary of 22 AFG Buy Recommendations from the S&P500 Index. The report highlights the 2 companies from each sector (ex. financials) that have the most attractive value score and are currently rated Buys by The Applied Finance Group, Ltd. (AFG). Factors used to derive a AFG’s recommendation include: Expected change in Economic Margins, Intrinsic Value, and Management Quality.

We also ran a VE analysis and provided the results. The VE analysis of each company is used to identify implied sales growth expectations versus what the company has delivered historically in sales growth over the past 5 years. Measuring the spread between a company’s VE sales growth expectations and what it has historically delivered should 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.

 Cheapest Companies In The S&P 500 By Sector (ex. Financials)

 Click Here, to see results of our portfolio performance using AFG's Buy/Sell criteria

A brief description of AFG's buy criteria 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 its peers.

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

 Applied Finance Group’s (AFG’s) Value Score defined - 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.

VE Sales Growth - AFG’s Value Expectations allows us to understand the Sales Growth, EBITDA Margin, and Asset Turnover a company has to deliver in the future to justify its current trading price. In theory, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The VE Sales Growth displays the implied future Sales Growth of the company assuming their EBITDA Margins and Asset Turnovers stay at the 5 year historic median levels.

Below is a look at the YTD returns, valuation attractiveness and sales growth expectations of the two biggest and smallest companies in each sector within the S&P 500 (excluding financials). This link provides some insight into Applied Finance Group’s (AFG’s) valuation techniques. Also compare the expectations for sales growth to what the companies have delivered historically to see which stocks on this list are most likely to meet or exceed those expectations, and thus be more likely to out-perform.

 Biggest/Smallest Companies (Mkt Cap) By Sector S&P 500 (excluding financials)

*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.

As 2009 approached, USA Today’s market experts gave us their insights/predictions on what they thought would happen in the upcoming year. Even as the world has changed dramatically since this list was released in December 2008, these “guru’s” picks are worthy of some attention to see how their predictions did against the overall Russell 1000 index so far this year. We ran their list through Applied Finance Group’s (AFG’s) set of screens that identify potential investment opportunities to see which companies they recommended met AFG’s criteria. Below is each expert’s picks and performance along with the performance of the Russell 1000 to benchmark against. The 6 companies highlighted (TAP, CSCO, WMT, PG, ABT, JPM) were the companies that met AFG's Buy Criteria (described below) for a potential investment opportunity and the rest failed to make the grade.

USA Today's Investment Pros - Picks For 2009

USA Today's Investment Pros Picks Vs. Russell 1000 - December 12, 2008 to March 17, 2009

A brief description of The Applied Finance Group's Buy Criteria 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.

Related: Read our Economic Margin white paper which was published in the book: Value-Based Metrics: Foundations and Practice Edited by: Frank J. Fabozzi and James L. Grant Pages 157 – 178: Click Here

Fortune magazine recently put out an article listing the most admired companies in the world.  We took the top 50 firms (excluding Financials, and companies not traded in the US) on their list and put them through Applied Finance Group's quantitative recommendation framework.  Just because these firms are among the most admired companies in the world does not qualify them as the most attractive investment. Being among the most admired is an honor and means you must be doing something right, but might not necessarily mean the share price is currently attractive. 

The following articles which we have posted in the past on ValueExpectations.com will give you a better understanding of what it takes for management to create wealth, understand Management Quality, and see how EPS alone falls short in estimating a company’s value. There are two main characteristics a company must have in order to be a good investment opportunity: (1) the company needs to be a strong economic performer, (2) the company should be attractively priced.   Many people admired the DeLorean, but it was neither a good performing car nor a good priced car. Below we reveal a few "DeLoreans" after looking under the hood.

Top 50 Most Admired Companies According to Fortune

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 Russell 1000 Index has lost 44% over the past year and is down 14% year to date. Similarly, the Russell 2000 Index is down 42% for the past 12 months and lost investors 18% since the beginning of this year. With both of these indexes down substantially recently by about the same amount, are large caps more attractive than small caps?

Percent to Target Charts: This graph shows the Percent to Target Current for a universe relative to the overall market. Values greater than 1 indicate the universe 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.

Small Universe: Companies in the AFG universe that have a market cap less than $300 million and EPS consensus estimates are available.

This chart illustrates that the median Small Cap company is currently overvalued, relative to the market. Over the past 6 years, small Caps have been trading at a premium to their historic valuation.

Large Universe: Companies in the AFG universe that have a market cap greater than $2 billion and EPS consensus estimates are available.

This chart illustrates that the median Large Cap company is currently undervalued, relative to the market. Large Caps have been trading at a discount to their historic valuation, indicating a potentially attractive opportunity.

Following is a list of the biggest 10 companies (determined by market cap) in the Russell 1000 and Russell 2000. AFG’s Value Expectations interface, which solves for implied sales growth embedded in a stock price (VE Sales Growth), allows us to understand the embedded 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. An undervalued company is more likely to outperform those companies with high expectations relative to what they have delivered historically. The tables below display the implied future sales growth of these companies assuming their EBITDA margins and Asset turnovers stay at their 5-year median levels.

Conclusion:
Both the percent to target charts and VE analysis show that large caps look more attractive than small cap stocks. The large cap stocks on the list have lower expectations for implied sales growth and the overall universe is currently undervalued. 

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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

When measuring the implied sales growth expectations priced-in to the eight biggest market cap companies in the Russell 2000 and the S&P 500, the larger cap S&P companies have lower expectations priced-in than the Russell 2000 companies. The median sales growth expectations, for the Russell 2000 is 11.76% compared to the 0.74% median priced-in to the S&P 500 companies. 

Given the bigger presence and management quality of these eight companies in the S&P 500,  we see them as a better investment oportunity based on the low expectations the market has placed into their current stock prices.

Top 8 Market Cap Companies and Sales Growth Expectations

Russell 2000

S&P 500