RIG

In 1963, business for American Express was booming: half a billion dollars of traveler’s checks were in circulation and over one million people had American Express cards. Then, scandal hit. An Amex warehouse subsidiary had issued receipts to Allied Crude Vegetable Oil Refining for bogus tanks of salad oil. The receipts were used to obtain loans on which Allied subsequently defaulted. When the creditors came to seize their collateral, the bogus tanks were exposed. While perhaps not legally bound, American Express assumed moral responsibility and was on the hook for $150 million – more cash than the company had on hand. Following the incident, American Express stock fell from $60/share to $35. As Amex’s share price fell, a little-known (at the time) investment manager named Warren Buffet purchased approximately 5% of the company. After determining that the scandal had no negative impact on cardholders’ propensity to use their Amex charge cards, Buffet concluded that the “salad oil scandal” was a one-time event from which the company could easily recover. His conviction was strong – at one point American Express accounted for more than 40% of his portfolio.

During the election, Teeka Tiwari released two blogs highlighting stocks to own based on who would become the next president. After reviewing the performance of both groups, the companies expected to do well after an Obama win failed to perform while those that were expected to be winners if Mccain won the presidential election did exceptional. The group of companies Tiwari mentioned as the stocks to own if Obama won the presidency returned an average of -26.38% compared to his stocks to own if McCain won the presidency averaged a healthy return of 12.89%. As an analysis of how these firms look as potential investment opportunities currently, ValueExpectations.com has reviewed all of these companies based on their valuation attractiveness, and identified whether the companies landed in the top/bottom half in expected economic profitability for the year ahead using our Economic Margin metric explained below. Companies that are attractive from a valuation standpoint and companies that are expected to improve their Economic Margin relative to their sector are the most attractive from an investment analysis and tend to outperform the market. No companies meet the selection criteria to be considered an AFG Buy Recommendation.

 

 

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.

Faisal Laljee of stocksandblogs.com came out with 2 blogs earlier this year providing companies that he believed were the top stocks to own/watch for 2009 (Part 1, Part 2). Laljee was on the money with his predictions so far through 2009. 13 of the 15 companies he recommended have positive returns and the whole portfolio of 15 companies has an average return of 21.24% compared to the S&P 500 return of 0.10% over the same time period. Valueexpectations.com thought it would be useful to analyze how these firms are positioned as possible investment opportunities going forward from AFG’s valuation standpoint. Valuation Attractiveness is determined by AFG’s proprietary valuation framework, which estimates a stock’s intrinsic value through a DCF model which incorporates a corporation’s Economic Profitability, Growth of Capital Base, Decay, and Cost of Capital. In addition, we also showed sales growth expectations embedded in each company’s latest stock price and its historical 5 year median sales growth. It is interesting but not surprising that all the Attractive stocks have low implied sales growth compared to those companies’ historical performance.

 

Stocksandblogs.com 15 Companies To Own/Watch In 2009 : Perfomance Results

 

*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 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 the list of companies assuming their EBITDA Margins and Asset Turnovers stay at the 5 year median levels.

Below is a list of the 12 most undervalued stocks in the Russell 1000. All companies listed met The Applied Finance Group's (AFG's) Buy screen (criteria explained below) and are in the bottom half of their sector in Market Value/Invested Capital (MV/IC) which by definition qualifies the companies as part of the AFG Value Universe. When identifying buy ideas AFG looks for companies with the most valuation upside compared to their sector peers, above sector median expected Economic Margin change, and a management quality score that reflects a management team following a wealth creating strategy. Also shown in the table is each companies implied sales growth expectations along with their historical sales growth. All 12 of these companies have very reasonable expectations for growing their sales relative to what they have been able to deliver historically. Companies with reasonable expectations embedded in their current price have proven to be more likely to out-perform than companies with high expectations.

 

12 Most Undervalued - Russell 1000 (excludes financials)

A brief description of AFG'sbuy 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.

Value Universe - Companies in the AFG universe, which have MVIC at the bottom 50% of the
universe and have EPS estimates.

Market Value/Invested Capital - The firm's average total equity, debt and other obligations divided by net invested capital.

 

*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.

For the past 26 years Steven Halpern, editor of thestockadvisors.com has gone to well known and respected advisors once a year to find out which stocks they like for the coming year. Take a look at the list of stocks advisors liked in 2008 and their performance. Also listed are the picks of 75 prominent advisors for 2009 along with sales growth expectations for the companies to justify their current price (VE Sales Growth) which can be compared to what they have delivered in revenue growth over the past 5 years(5 Year Median Sales Growth). These companies are worth a look because they are in favor of well-respected advisors, but the companies that also have low expectations for sales growth priced-in to their stock are especially worthy of a close review.

 

2008 Blogger Picks Conservative and 2008 Performance

 

2008 Blogger Picks Speculative and 2008 Performance

 

Blogger Picks for 2009 and Sales Expectations

* denotes # of years historical sales numbers available

VE Sales Growth calculated for these firms on 1-6-09

According to MotleyFool.com, InvestorPlace.com, Jubak’s Journal, Cramer, and FortuneMagazine.com these are the most attractive stocks to own in 2009. Compare the sales growth priced-in to justify the current stock price (VE Sales Growth) to what the company has achieved in revenue growth over the last five years (5 Year Median Sales Growth) to see if what’s priced-in is a reasonable number for the company to meet or exceed expectations. Couple the expectation information with AFG’s ranking for a stock’s attractiveness relative to the universe (Value Score AFG) to find companies that we find attractive on a default basis that also have low expectations for growing sales compared to what they have delivered the past 5 years. Companies with High Value Score’s and low sales growth expectations will be the companies on this list that are more likely to out-perform.

 

Recommended Stocks for 2009

Related Article: EPS Increased.....Company Underperformed?

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Nearly all of the biggest return earning companies in the S&P 500 are firms that have been beaten up over the past few months but have bounced back to provide the biggest return in the entire index for the month of December. These firms have ended 2008 on a high note and move into 2009 with what they hope to be sustainable momentum.

The list of companies in the S&P 500 with the worst returns in December had also been trending downward for the past few months but were unable to muster a year-end turnaround as those on the other list had been able accomplish. Many of the firms on this list have something to do with oil, as their stock prices have been highly correlated with the falling price of oil.

Compare the sales growth priced-in to justify the current stock price (VE Sales Growth), to what the company has been able to deliver the past 5 years in revenue growth (5 Year Median Sales Growth), to see which companies have reasonable expectations of achieving the Sales Growth priced-in. Companies with low expectations relative to what they have been able to achieve are more likely to out-perform.

 

Sales Growth Expectations for the Highest Return Companies (S&P 500) - December

**denotes only 2 years historical sales growth available (2 year median used)

 

Sales Growth Expectations for the Lowest Return Companies (S&P 500) - December

 

VE Sales Growth Calculated for these firms on 12/26/08.

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

 

 

EQ is important in this current market environment because so many companies are feeling pressure to meet their sales expectations. Many companies are channel-stuffers, which is one form of accruals that often leads to negative earnings surprises. A recent poster-child for this example of sending excess inventory to stores that could not sell their products would be Crocs and the way they tried to pad their sales numbers.

Earnings Quality: Accrual

•An accrual is the difference between Cash Flow and Net Income.

•Net Income = Cash Flow + Accruals

•Low Accrual companies outperform high accrual

 Two ways to approach accruals:

1. Cash Flow Statement

•Difference between Net Income and Cash Flow

2. Balance Sheet

•Change in Net Operating Assets from Period t-1 to t

•Net Operating Asset equals Total Assets Less Cash, Less Non-Debt Liabilities (excl. Minority Interest)

-Our studies show that the Balance Sheet approach is superior to the Cash Flow Statement approach.

-We found the Balance Sheet approach is also easier to expand to international companies.

 We screened the  S&P500 to identify those firms with the worst EQ scores. The score is given from 1-100, 1 being the best EQ company, 100 being the company with the highest amount of accruals and the worst EQ. Because high EQ companies are more likely to have negative earnings surprises, this is a group of companies you may want to avoid. The EQ variable works well as an exclusionary variable coupled with AFG’s valuation model.

After running our screen we identified 14 firms as the worst Earnings Quality firms. You can set yourself up for success and save time by narrowing your list of constituents to only those that meet our standard valuation, Economic Margin and Management Quality checks and following that up by filtering out those companies most likely to have negative earnings surprises (high EQ). The Chart Below identifies the firms that met our screen criteria, along with the EQ score and our VE analysis.

 

Worst 10% Earnings Quality Companies In the S&P 500

 

 

Universe Size: 4,000 to 5,000 Firms

Source: Applied Finance Group Database from 9/1998-5/2008

 This variable does not add any value for companies within the financial sector and those companies are automatically screened out when using this variable.

Recently we also screened the S&P 500 to identify investment opportunities and identified over 150 companies (industrials) that have negative sales growth expectations embedded into their current market valuations. These companies include high quality companies such as: COH, DOW, CAH, TGT, JNJ, UTX, SBUX, and WAG, among others. If you would like to Read our study Click Here