Value Expectations's blog

This simple question, posed by legendary value investor Bruce Berkowitz, puts the consensus concerns surrounding the managed care industry into perspective. The bottom line is that the health insurers are the only shot we have at managing this mess. As much as he might like to, Obama does not have another entity to do it. And our growing government does not have the expertise or efficiency to manage the process. The bear case for these stocks is well known and well discounted even at today’s levels. Let’s take Humana (NYSE:HUM), for example – 60% of the analysts that cover the company rate it “hold” or worse. To help put this number in perspective, a whopping 1% of the S&P 500 is rated “sell” today. So suffice it to say that the “bad stuff” is in the price. And when the bar is set low enough, it is not difficult to surprise on the upside. Perhaps this is why earnings estimates for the company have been marching steadily higher in recent months. So let’s consider some of the potential “good stuff” that might shift sentiment in the period ahead:

An outlook of the expectations for sales growth of the average companies in the main indices across the world including the S&P 500, Nikkei 225, FTSE 100 and others to provide some insight into whether the markets around the world currently look over or undervalued. The charts below are recent snapshots of the expectations of different markets around the globe vs. what each market has been able to deliver historically. Much like understanding the expectations that are priced into a stock, these charts help clients to better understand whether the market has high or low expectations currently priced in.

February was a good month. The S&P500 companies reported good Q409 results, with 75% of the constituents beating earnings estimates, and 10% meeting. In addition, the overhang of the widely unpopular health care reform seemed cleared, with Republican candidate Scott Brown elected to the Senate, ending the Democratic Party’s 60-vote filibuster proof majority. Investors’ optimism rose, sending the S&P500 index up by 4%, largely reversing the loss in January. High beta stocks led the way, with the top quintile stocks outperforming the R1000 and R2000 indices by 2.21% and 4.14% in the past month. (Equal weighted return. Please refer to What’s Working portion of the letter.)This has certainly been a much more pleasant start to the New Year compared to 12 months ago. A year ago, we were on a roller coaster ride, witnessing the S&P500 losing 8.6% in January, the worst in history, losing 11% in February, the second-worst on record, followed by a loss of 4.66% on the first trading day of March, another worst in history. Back then, we were attacked by horrific economic news on one front after another: a disheartening GDP decrease of 6.2% in Q4 2008, skyrocketing unemployment, falling home sales and prices, rising credit card defaults, and continuing banking troubles. Amid debates on the merit of “capitalism”, investors were dumbfounded by government’s plans to “save” the economy: the $787 billion stimulus bill, the Homeowner Affordability and Stability Plan, and the President’s ambitious budgets suggesting historical deficits for the country. The Federal Reserve made its own contributions to the rescue efforts, injecting $1.75 trillion into the economy starting in March 2009, including purchasing $1.25 trillion of agency backed mortgage securities and $300 billion longer maturity treasuries.

A popular belief among the economic commentariat today is that the mere existence of the Federal Deposit Insurance Corp. represents "moral hazard." With bank deposits insured, the common thought is that bank executives feel more comfortable taking massive risks because their losses will be covered by the taxpayer. Well if we ignore that banks themselves fund the government bureaucracy that is the FDIC, the hypothesis about deposit insurance and moral hazard is questionable. Indeed, by virtue of bank executives having much of their net worth tied up in the banks they run (bonuses are heavily weighted toward restricted stock in the bank, as opposed to cash), it's a bit of a reach to suggest that deposit insurance--which doesn't protect the share prices of banks from collapse--somehow fosters excessive gambling meant to imperil that same net worth. But what critics often fail to ask is why savings accounts are so sacred, and why the government-chartered FDIC, as opposed to a private version, has to insure those accounts. The answer we commonly hear is that without federally mandated deposit insurance, individuals would hide money under mattresses and banks would have no savings to lend.

A list of the most attractive stocks in Japan from within the Nikkei 225 index. Using AFG’s valuation techniques we screened down the Nikkei 225 to the 25 most attractive stocks that are more likely to outperform their sector peers. As a further layer of analysis we removed those companies that met AFG’s Valuation criteria that also had a high level of accruals which AFG has proven to cause firms to become more vulnerable to negative earnings surprises.

This past Saturday, Warren Buffett released Berkshire Hathaway’s 2009 annual report and his annual letter to Berkshire shareholders.* The last Friday in February has become like Christmas Eve for value investors the world over. A night of tossing and turning is followed by a mad rush to the computer to download the latest version at 8am on Saturday morning. And then, maybe 30 minutes later, melancholy as we all realize that Mr. Buffett won’t write to us again for 365 days. As admirers of Mr. Buffett, frequent shareholders, and practitioners of the “value” approach to investing, you could count us among the sleep deprived on February 27th.

The 25 most actively traded stocks in the S&P 500 based on trading volume, ranked by valuation and investment opportunity attractiveness. These companies seem to garner the most attention from within the investment community, so we decided to add our insights into which of these firms look attractive and worthy of the hype and which you may want to avoid.

The example we have provided is Texas Instruments Inc. (NYSE:TXN) a company that currently looks undervalued according to AFG’s default valuation model. An important fact to note is that AFG has shown it tracks Texas Instruments Inc. (NYSE:TXN) well (high accuracy score of 100). Also, Texas Instruments has a current AFG Value Score of 82, meaning the company ranks in the top 82nd percentile of companies in the AFG universe in valuation attractiveness. Companies AFG identifies as undervalued have proven through back-tests to be more likely to outperform than those companies with an unattractive default AFG valuation rank.

The Applied Finance Group (AFG), an independent equity research firm, would like to invite professional investors/money managers to participate in AFG’s Market Forecast Project (MFP). The MFP is a professional investor sentiment survey designed to help money managers make more informed investment decisions, enhance client communication and provide an edge in the portfolio construction process. The main focus of the MFP is to provide participants investment ideas, macro-economic sentiment and stock market predictions of a large and diverse group of investment professionals to see how other professional money managers in the industry view the market.

A list of the 8 cheapest stocks from within the Hang Seng index. The Applied Finance Group's (AFG’s) Economic Margin Framework provides a systematic approach to converting as-reported accounting data into a performance metric that is comparable across time, peers, industries and even countries while eliminating many of the accounting distortions inherent in GAAP. The ability to understand the true economic profitability and the underlying intrinsic value of a company using one consistent method is why AFG expanded its framework internationally. Now investors all over the globe can take advantage of the same institutional quality research and investment tools that AFG’s U.S. clients have been using since 1996.

Coca-Cola Co (KO) announced its acquisition of the North America operations of its top bottler, Coca-Cola Enterprises Inc (CCE) at a value totaling approximately $12.2 billion, by assuming $8.8 billion of CCE debt and relinquishing its 34% equity ownership in CCE, valued at $3.4 billion. This acquisition, which is expected to close in the 4th quarter of 2010, is largely viewed as a strategic reversal to close a competitive gap after a similar deal by Pepsi Co, which just completed the purchases of its largest bottlers, Pepsi Bottling Group Inc (PBG) and PepsiAmericas Inc (PAS). In a concurrent agreement, CCE also agrees to buy Coke’s bottling operations in Norway and Sweden for $822 million. CCE will also have the right to acquire Coke’s 83% equity stake in its German bottling operations 18 to 36 months after closing for fair value.

The wise minds of the financial world have, it seems, reached a banking compromise that will please everyone. Banks benefiting from their FDIC backing and ability to access the Federal Reserve's discount window will be required to curb their speculative activity, while those that do not receive explicit government aid will be free to take big risks as well as fail. Former Fed Chairman Paul Volcker is the author of this plan, and in a letter to the editor in last week's Wall Street Journal, former Treasury secretaries W. Michael Blumenthal, Nicholas Brady, Paul O'Neill, George Shultz and John Snow lent their support. The bipartisan backing of the Volcker Rule by some of the "gray eminences" of finance seems to suggest relatively easy passage of his idea, despite rumblings last week that the U.S. Senate wasn't exactly sanguine. At first glance it is hard to argue with Volcker's solution. If financial institutions want the alleged good of government subsidy, they should also accept the bad in terms of greater restrictions. More important for those who were bothered by the recent bank bailouts, failures among firms outside the government's umbrella will be allowed.

A focus list of buys and sells for our readers to use as a starting point when looking to make changes to portfolio. This list contains attractive and unattractive stocks from every major sector excluding financials. AFG's buy and sell lists have proven through time to provide a significant spread between the buys and sells helping you to identify winners and avoid potential torpedoes.

James Glassman of MSN Money provided a list of the 25 best performing stocks of the past decade and says the list is a good starting point when looking for the best stocks of the next decade because of their solid past performance. Although ValueExpectations does not share the same sentiment regarding past performance, we set out to analyze the top performing stocks of the last 10 year to determine which companies are most likely to continue their impressive run.

An analysis of the expectations for sales growth embedded in the stock prices of every S&P 500 company needed to justify the current price. Sector averages of embedded expectations relative to 5 year median historical sales growth gives valuable insight into which sectors look the most undervalued and have the most realistic expectations compared to what they have been able to deliver in the past. The more realistic the expectations, the more likely it will be to meet or exceed those expectations.