PPG

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 pool of companies to choose from for their portfolio holdings. However, picking winning investment opportunities isn’t the only value AFG provides clients. AFG also develops quantitative strategies to quickly identify possible torpedoes lurking in your client or prospective client’s portfolio.

AFG’s quantitative process is centered on the proprietary Economic Margin (EM) Framework (what a company earns above its true cost of capital). 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 is available below the list of companies.

When identifying potential 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 20 S&P 500 companies from every major AFG defined sector (ex. Financials) 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 or consider adding one to your portfolio, we suggest taking a closer look as they look the most likely to underperform their sector peers according to criteria that has proven successful at identifying winners and losers in the market.

If you are a professional investor and would like to learn more about AFG’s EM methodology, investment criteria or stock selection process click here to register to trial the product.

     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.

+View our List of Value Expepectations Recommended Articles

AFG Recommendation Performance
9/1998 – 5/2009
Annualized Returns

Other Market Related Articles of Interest

Source: AFGView client databases from 9/1998 – 5/2009
Universe size: 4,000 to 5,500 firms

The Applied Finance Group’s (AFG) Market Forecast Project is a monthly poll of professional investor’s designed to provide insights on how investor’s currently view the market and economy. This poll started out as an AFG client only poll at AFG’s annual research summit, but due to its popularity and successful predictions it has been expanded to all professional investors who register and participate and will be done monthly. The benefit of participation is being the first to receive the results before they are released on our blog or to anyone else. Earlier this month as a result of one of the poll’s questions that the Tech sector was the most attractive sector to invest in over the next 12 months, we released a list of Tech stocks that we like and a few that looked overvalued as well. In last month’s survey the Basic Material sector was the second most attractive place to invest due to the fact that many investors see an economic recovery ahead that may directly benefit many of the companies within the Materials sector when home building and new construction begin to correct and recover. Provided below is a list of Basic Material stocks that we find attractive and unattractive based on AFG’s default buy/sell criteria, valuation attractiveness and expected change in Economic Margins (AFG’s measure of corporate performance/profitability). Companies expected to improve Economic Margins greater than sector peers have proven through back-tests to be the most likely companies to outperform. Companies with attractive default valuations according to AFG have also consistently outperformed companies AFG views as overvalued.

Source (The Applied Finance Group)

*Valuation & EM Change are Ranks within their sector

AFG's Buy/Sell Criteria - factors in Economic Margin, Management Quality, and AFG's Valuation Metric. In order to determine Management Quality, AFG scores management on their growth decisions in accordance with the company’s ability to either create or destroy wealth. AFG's Valuation Metric measures a company's Percent to Target (the 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.

If you are a professional investor and would like to be a part of our next survey click here.

By using The Applied Finance Group’s (AFG's) Risk Analysis, we have identified the top and bottom two firms in each sector (excluding the Financial sector) according to an overall risk score based on 9 variables (see more detail below). In addition to the risk analysis variables we also added another layer of analysis by evaluating the companies’ Earnings Quality (based on the concept of Accruals) and Altman Z-Score (identifies firms that are at risk of going bankrupt in the next 2 years).

Applied Finance Group’s Risk Analysis is designed to systematically calculate a stock’s risk score based on fundamental relationships between the Quarterly Income Statements and Balance Sheets. The template measures 9 factors to determine Risk: Changes in A/R, Changes in Inventories, Cash Flow vs. Operating Cash Flow, Fixed Payments vs. Pre-Tax Cash Flow, Leverage, Intangibles, Write-offs, Management Quality, and Valuation. Companies with lower scores have less risk. Companies in the Financial Sector were excluded due to their differences in financial statement structure.
 

1. Receivables to Sales - Delta – takes the difference in the median A/R to Sales ratio over the last 4 quarters vs. median 4 quarters before that.

2. Inventories to Sales - Delta – takes the difference in the median Inventories to Sales ratio over the last 4 quarters vs. median 4 quarters before that.

3. AFG’s Cash Flow-Oper. vs. Operating Cash Flow - AFG's Cash Flow-Oper. for a company is net cash that is generated by the continuing and discontinuing operations of the firm. We compare it to the company's Operating Cash Flow to assess its ability to pay its debt.

4. Fixed Payments vs. Pre-tax Payments Cash Flow – This ratio assesses the company’s ability to cover long-term obligations. If the fixed pmts are greater than 50% of the pre-tax payments cash flow, there is chance that this company may not be able to meet its obligations. Obligations less than 30% of cash flow are considered safe.

5. Leverage – Book leverage and Market leverage are analyzed to give us information about the company’s leverage position. Best score is given to the companies with Book Leverage lower than 60%, and negative score to these with Book Leverage higher than 60% and Market Leverage greater than 0.9*Book Leverage.

6. Intangibles as a Percentage of Total Assets – With this score we try to filter through and reward the companies that have grown organically, rather than through acquisitions. Our research has shown that on average companies tend to overpay for acquisitions and thus are rarely a profitable investment. Companies with Intangibles less than 20% of Total Assets get the best score.

7. Write-offs – Shows the number of years with significant write-offs over the last 5 years.

8. Management Quality – Measures a company’s EM+1 and LFY Asset Growth and there is empirical evidence that companies with positive EMs that are able to grow their business tend to outperform companies with negative EMs who continue to invest into unprofitable business.

9. Value Score – Measures a company’s attractiveness from valuation perspective.

Most/Least Risky Firms By Sector S&P 500 (excluding financials)

If you are a professional investor and would like to learn more about this analysis as well as other useful valuation tools click here for a free trial subscription to The Applied Finance Group's research.