The majority of the themed-portfolios and research products that we offer at AFG revolve around identifying undervalued stocks that look like attractive investment opportunities we think our clients or readers should consider adding to portfolios. While it is very important for money managers to discover the next attractive investment opportunity poised to deliver solid returns, it is just as vital to be able to identify and avoid potential torpedo stocks that could blow up your portfolio. For this reason, we will identify 12 S&P 500 stocks that have characteristics commonly found in companies likely to underperform.
We utilize AFG’s multi-factor Investment Grade model to assign a simplified letter grade (A-F) and identify the companies to own and avoid based on overall Investment Grade. Several of the individual factors within the model have successful track records as exclusionary variables on a standalone basis, as they consistently flag companies that underperform. AFG’s Earnings Quality Grade which flags companies with very high levels of accruals and Management Quality Grade which flags companies following a wealth-destroying management strategy are two factors that have consistently helped to identify potential torpedoes. The chart below highlights the performance achieved by the Investment Grade model since inception. Investors who avoid F Grade stocks and only own A Grade companies have tended to do very well.
Being that the Investment Grade model has been so successful at identifying companies that tend to underperform, as evidenced by the performance of “F” Grade companies, we want to provide a list of companies that have been flagged as potential torpedoes. The 12 companies listed below all currently earn an Investment Grade of “F” and also look very overvalued from a valuation perspective. This list can serve as a red flag for investors who may own any of these companies or are considering adding any of these names.