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When narrowing the market to a focus group of stocks to choose from, The Applied Finance Group (AFG) has a core set of principles we concentrate on to develop a group of stocks that are more likely to outperform the market.

In a recent Article by John Tamny, Forbes: To Fix The Global Economy, Fix The Dollar, the effects of a weakening dollar on the U.S. Economy were nicely summarized “When money loses value, it's the equivalent of governments raising the rate at which we pay income taxes. But with taxes, we can at least see how much the government is removing from each paycheck.”

A weakling dollar will likely be followed with higher inflation.   Although there are some who believe that a weaker dollar will strengthen our exports, the reality is that companies will be spending more to produce their goods and investors will require higher nominal pre-tax rates of return. Furthermore, an increase in the overall cost of capital for equities will result in less business expansion as companies must pay more to source their funds. 

So how do investors deal with a sluggish economy and declining dollar? As the U.S. economy faces many headwinds with a declining dollar, we recommend high quality, well managed, attractively-priced businesses with high foreign exposure.   Companies with a significant overseas exposure will likely benefit from currency appreciation against the dollar making sales in those currencies especially valuable.  

 
Using AFG’s proprietary research we thought we would provide you a solid list of well managed businesses, in the S&P 500 that also have over 50% in foreign sales.

Using AFG’s proprietary research we thought we would provide you a solid list of well managed businesses, in the S&P 500 that also have over 50% in foreign sales.

 Source: The Applied Finance Group

Valuation Signal  – 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 (EM) Signal- 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.

For further guidance, we decided to contact John Tamny to ask him for his insights on what kind of stocks investors should be looking at?

John Tamny: If the dollar continues to weaken, investors will want to be in companies that are rewarded for finding physical assets of the earth (oil, gold, various commodities and businesses that serve commodity companies), while if the dollar were to strengthen or stabilize, investors would more want to be in intellectual companies such as software and other innovations

On Wednesday November 18th, Mr. Tamny, Toreador Economic Advisor and Forbes columnist will be discussing many of the reasons why a declining dollar has been hurting the growth of the US Economy along with:

• Should the dollar move to a gold standard?
• Is a trade "deficit" bad for the US Economy?
• Why a stable dollar is an essential input when it comes to economic growth.

Click here to get a replay of this talk!!

About the AFG Screener

Professional investors have many ways to screen and narrow their list of constituents to create a focus list of companies they use to select from to develop their portfolios. In the industry, there are many screeners that are part of subscriptions to databases and investment tools, however, many of them do not provide guidance on the best screening methods to use. Created by The Applied Finance Group (AFG), the AFG Screener tool is a web-based company-screening application located on AFGView.com that is designed to save you time when narrowing your list of constituents. More importantly, AFG’s screener allows you to use proprietary variables that have been proven to outperform, helping investors make better investment decisions.

AFG’s Screener allows clients to find aggregate groups of companies that meet specific criteria from AFG’s entire global universe of over 14,000 securities. Using the Screener, one can find a list of companies that either match one of AFG’s preset screens or one based on a customized screen that you create.

The AFG Screener identifies attractive valuations, strong management teams, corporate performance, and the quality of earnings of a company as well as all traditional financial variables,

Because AFG’s Screener is web-based, clients can gain access from anywhere that has an internet connection, convenience and ease of “one-click screening” with our default screens, various forms of result presentations, and compatibility with Microsoft Excel for further analysis.

How to Use AFG’s Screener

Access AFG custom built screens that many clients regularly utilize that include AFG’s proprietary Economic Margin (EM), valuation and management quality variables along with many others.

Build your own custom screens using any variables you are familiar with such as price multiples and other accounting information by themselves or coupled with powerful AFG variables with just a few clicks of the mouse.

Once you have narrowed your list of constituents to those companies that meet your specific criteria you can easily upload your new list into AFG’s valuation model to analyze each company in greater detail or see how they rank vs. their peers on key AFG variables.

Default / Custom Screens

Whenever a new user is introduced to AFG’s Screener, they are provided with two default screens – AFG’s Default Buy screen and AFG’s Default Sell screen. Using these screens, one can filter companies based on AFG’s buy/sell criteria.

However, the AFG Screener is very intuitive allowing clients to create their own screens based on custom criteria. There are countless combinations that can be used to create a custom screens, as there are over 600 variables to choose from. AFG’s Screener tool can be used to list companies based on Indexes, Sectors, Industries, and previously created Portfolios.

Using Excel / Further Research

AFG screens can also be accessed using AFG’s Excel add-in to combine results with other spreadsheets or to create a report for your investment team. Exporting your information will give you more freedom to read, organize and document your data as well as pull in other variables within AFG’s Excel add-in to easily rank order your list of companies based on the same variables available within the screener.

Example Screen:

Below is a list of 12 companies that resulted from a quick screen that sought to identify those companies within the S&P 500 with attractive valuations, market cap above $1 billion, expected to improve EMs greater than sector peers, and that have a current stock price of under $30. Improving EMS and an attractive default AFG valuation rank is a good place to start when looking for the companies most likely to outperform. This is just one simple example of the capabilities of using AFG’s screener tool to select a focused list of stocks that are the most likely to outperform and a list that is worthy of more time spent on due diligence on the companies that meet the specified criteria.

The Applied Finance Group would also  like to invite professional investors to join AFG’s Market Forecast Project so you can better understand what your peers currently think about the market and cultivate the “wisdom of Crowds” into actionable investment ideas and themes.

Register to View Complete Market Review and Sector Analysis, it's FAST and FREE!

In recent weeks we have written several blogs (S&P 500 sector stock watch, Attractive stocks under $35, with potential investment opportunities, Solid S&P Value Companies, Cheapest Stocks In the S&P 500), discussing investment opportunities within the S&P 500. These stocks ideas all had favorable scores under The Applied Finance Group's (AFG’s) investment criteria, which includes economic performance, valuation, earnings quality and management’s ability to create shareholder wealth, among other criteria.

Another way that AFG identifies potentially attractive investments is through the use of its Value Expectations interface, which helps investors get a better understanding of the expectations embedded into stock prices. This interface 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 below displays the implied future Sales Growth (“Priced-in Sales Growth) of the companies we have recently recommended in our recent blogs, assuming their EBITDA Margins and Asset Turnovers stay at 5-year median levels.

To identify potentially attractive investment ideas, The Applied Finance Group (AFG) uses a combination of proprietary variables including valuation, economic performance, management quality, and Earnings Quality. In December of 2008, ValueExpectations.com released a list of companies sorted only by AFG’s Value Score (defined below). Our valuation techniques have proven successful at identifying mispriced securities, which has helped our clients select stocks that outperform their chosen benchmark.

The ValueExpectations.com blog posted in December 2008 (High Value Score Stocks - S&P 500), contained these high Value Score companies (DDS, S, NOV, MTW, SII, WFR, CHK), and outperformed the S&P 500 by 40% as of our 3-26-09 performance update. We recently checked the average performance of those picks through 8-27-2009 to find that they have returned an astounding 52% above the S&P 500, with 6 of the 7 companies outperforming. High Value Score Stocks Part 2, released on 5-7-09 has also outperformed the S&P 500 by nearly 3% since its release, with a batting average of just over 60%.

Due to the success of the first two “High Value Score” blogs, we again used valuation as a basis for selecting a new set of investment ideas. Listed below are the top 10 companies in the S&P 500 (excluding Financials) based on AFG Value Score alone. These companies look the most attractive from a valuation perspective relative to the rest of the index.

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).

Back in February Valueexpectations.com released a blog highlighting Fidelity’s Low Priced Stock Fund that follows a strategy of only investing in stocks with a share price of under $35. In that blog we provided a list of 30 stocks that we thought were attractively priced according to The Applied Finance Group’s (AFG's) valuation model broken up into three price brackets: under $10, $10 to $20 and $20 to $35.

From Feb 5th 2009 to June 5th 2009 the 30 stocks recommended as a group outperformed the S&P 500 by an average of 36.5%, the 10 stocks under $10 outperformed by 57.1%, the $10 to $20 stocks outperformed by 40.1% and the $20 to $35 stocks outperformed by 12.5% respectedly. 

Joel Tillinghast, the fund’s manager began this fund with a strategy of only investing in stocks under $10. Since this stragtegy began Fidelity has moved the stock price limit to $35 where it currently sits. Tillinghast believes that share price alone is not of importance but the lower priced, smaller-cap universe of stocks experiences the most frequent mispricing’s and also has the least amount of analyst coverage.

As an update to the prior blog on this strategy Valueexpectations.com provided a list of 30 stocks that we believe are attractively priced and do not fit AFG's default sell criteria. Each group is ranked based on valuation attractiveness. AFG's analysis begins and ends with valuation, however along the way there are other key factors AFG considers when looking for buy opportunities: expected Economic Margin improvement, management quality, earnings quality.

Attractively Priced Companies Under $30

Bloomberg provides a score for companies within the S&P 500 based on an average of all analyst ratings from the street. Below is a table highlighting companies with the best analyst ratings, largest increase in rating, highest price targets, and worst analyst ratings and the valuation attractiveness of each of these companies based on The Applied Finance Group’s (AFG) valuation model.

Companies within each of these groups are ranked from most attractive from a valuation perspective to the least attractive. VE.com will actively track the performance of these recommendations and see how they stack up to the analyst recommendations in each group. AFGview.com, AFG’s professional investor website allows you to compare any company using their rating versus the consensus ratings of the sell side. If you are interested in an analysis on a specific company, contact afgsales@afgltd.com.

Best/Worst Analyst Rated Companies (Bloomberg)

AFG's 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.

The Halloween Indicator in the stock market sometimes defined as “sell in May and go away” is a strategy that is based on the difference in the performance of the market during May to October vs. November to April. The strategy is to invest in the S&P 500 during “the best 6 months” and switch to bonds during “the worst 6 months” to avoid the summer doldrums of small to negative returns. Since January of 1950 the average returns for November to April “good months” is 7.9% compared to the 2.5% average return delivered from May to October ‘bad months”.

Although there is a significant spread in returns between the good and bad months, does this mean you should convert to bonds and go on a vacation until September? There are several views for and against market timing but we feel it is too difficult to identify when to be out and when to be in the market. If you dig deeper into the market performance since 1950, you will find that 20 good and 20 bad months make up a significant part of the market performance. For more information read the following market timing strategy filled with pitfalls.

The market has been up in those worst 6 months 60% of the time since 1989, not as profitable as the best 6 months but still positive. I believe 2009 is a good lesson for many, with all of the inefficiencies and irregularities in today’s market, the mixed macro economic reports, and the belief we are headed toward a recovery, jumping out of the market could mean missing out on making up for some of the losses the market handed us in 2008

However, being invested isn’t enough, identifying quality companies and a good value will put you in an even better position to outpace the general market. Listed below are companies that should be considered as potential investment opportunities. These companies all have a valuation attractiveness near the top of their sector in addition to expected improvement of profitability (Economic Margin) above their sector, and do not follow a wealth destroying strategy defined by AFG’s management quality score.

Attractive companies to consider in each sector instead of selling in may and going away

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.

 

To identify potentially attractive investment ideas, AFG usually uses a combination of proprietary variables to develop of focused group of potential buy ideas that meet criteria based on valuation, economic performance, management quality, and Earnings Quality. In December of 2008 ValueExpectations.com released a list of companies narrowed only by the valuation properties of the company using AFG’s Value Score (defined below). Our valuation techniques have proven successful through time at identifying mispriced securities and helping our clients identify investment opportunities resulting in outperforming their chosen benchmark. .

The ValueExpectations.com blog posted in December 08 (High Value Score Stocks - S&P 500) contained these high Value Score companies (DDS, S, NOV, MTW, SII, WFR, CHK) had returned 40% above the S&P 500 as of our 3-26-09 performance update and a recent check of that performance on 5-5-09 was even better, currently these companies have returned an astounding 64.5% above the return of the S&P 500 during the same time period (12-29-08 to 5-5-09).

In this exercise we used valuation independent of other key proprietary variables we use to identify good investment opportunities. Although valuation works well on a stand-alone basis, it works even better when used with AFG’s Economic Margin, Management Quality, and Earnings Quality variables.

Listed below are the top 10 companies in the S&P 500 (excluding Financials) based on AFG Value Score alone. These companies all look the most attractive from a valuation perspective relative to the rest of the index.

AFG High Value Score Stocks

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.

Fidelity’s Low Priced Stock Fund, which launched in 1989 (18 Billion AUM) and is managed by Joel Tillinghast, follows a simple strategy… Only invest in stocks with a share price under $35. This strategy first started with Tillinghast only investing in stocks below $10 a share, but later he moved the limit up to $35 a share. He argues that share price alone is not important but that the small-cap universe contains the most frequently mispriced stocks and the least amount of analyst coverage.

Although his fund at best has been a market performer as of late, Tillinghast had taken advantage of such mispricing’s during the last 15 years, averaging an 11% annual return compared to the 6% return earned by the S&P 500 over the same period. The fund had been closed to investors since 2003, but was recently reopened in December. Fidelity says they reopened the fund to get more cash inflow to be able to take advantage of all of the investment opportunities they see in the market.

Below is a list of the top holdings in Fidelity’s Low Priced Stock Fund as well as stocks that AFG believes are attractively priced in three price brackets: under $10, $10 to $20, and $20 to $35. Compare the implied sales growth priced-in to justify the current trading price (VE Sales Growth) vs. what the company has delivered in sales growth the past 5 years (5 Year Median Sales Growth) to see if the expectations are realistic for the company to achieve. The more realistic the expectations are, compared to what has been delivered, the more likely the firm will be to out-perform.