BIIB

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.

A list of attractive stocks from within the Health sector that meet AFG’s definition of attractive based on Valuation, Corporate Performance, Management Quality and other key criteria AFG uses to identify the stocks that are most likely to outperform from within each sector. The Health sector has consistently ranked as the 2nd best sector to invest in (next to Technology) over the next year according to participants of The Market Forecast Project, a monthly survey of professional money managers.

ValueExpectations.com emphasizes evaluating a company’s ability to earn a spread above their cost of capital using a very robust measure of corporate performance, Economic Margin. After evaluating a firm’s ability to create wealth VE.com then determines what price we are paying for the company using a modified discounted cash flow model. If we had to simplify performance, a very elementary way to evaluate performance can be Return on Invested Capital ROIC and valuation which can be simplified by using earnings yield. This is the approach Joel Grenblatt uses in his book, The Little Blue Book that Beats the Market.

In January VE.com highlighted a list of stocks based on Joel Greenblatt’s Magic Formula Investing Strategy from 1998-2004 Greenblatt’s simulated returns were 30.8% a year, relative to a 12.4% annual return for the S&P 500 and was only down in one year in that time-span.

In our article posted on January 9, 2009 we listed our best 30 “Magic Formula” companies which has earned returns comparable to the tests conducted by Mr. Greenblatt. From Jan. 9, 2009 to Dec. 14, 2009 the 30 companies we recommended from our “Magic Screen” have returned a solid 32.06% spread above the S&P 500. Since our last “Magic Formula” portfolio was successful we have decided to run the screen again for a new list of companies to see just how consistent this strategy is.

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A look at Greenblatt’s formula for successful “Magic Formula Investing”:

1. Establish a minimum market capitalization (usually greater than $50 million).

2. Exclude utility and financial stocks

3. Exclude foreign companies (American Depositary Receipts)

4. Determine company's earnings yield = EBIT / enterprise value.

5. Determine company's return on capital = EBIT / (Net fixed assets + working capital)

6. Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages).

7. Invest in 20-30 highest ranked companies, accumulating 2-3 positions per month over a 12-month period.

8. Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.

9. Continue over long-term (3-5 year) period.

Mr. Greenblatt was a student of both Ben Graham and Warren Buffet and tried to include valuable insights from each investor in his “Magic Formula.” His Magic Formula was a screen that percentile ranked two variables: Return on Invested Capital (quality) and Earnings Yield (valuation). The idea is simple, buy the best companies at the best price and then hold on to them for one year. The Little Blue Book recommends selecting the top 30 firms from the “Magic Formula.” That formula ranks each company by variable and then puts a 50% weight on each.

Ticker  Company Name Sector Market Cap ROIC Earn Yield (NYSE:PM) Philip Morris Intl Inc Consumer Non Durable $96,066 265% 26% (NYSE:LO) Lorillard Inc Consumer Non Durable $12,671 111% 13% (NYSE:RAI) Reynolds American Inc Consumer Non Durable $15,560 116% 14% (NYSE:NOV) National Oilwell Varco Capital Goods $18,530 38% 17% (NYSE:ABC) Amerisource Bergen Corp Health $7,198 82% 12% (NASDAQ:APOL)  Apollo Group Inc Cl A Miscellaneous $9,602 164% 12% (NYSE:GD)  General Dynamics Corp Capital Goods $27,261 69% 12% (NYSE:BF.B)  Brown-Forman Corp Cl B Consumer Non Durable $8,335 124% 18% (NYSE:TSS)  Total System Services Consumer Services $3,439 50% 16% (NYSE:DNB)  Dun & Bradstreet Corp Consumer Services $4,285 -395% 10% (NYSE:LLL) L-3 Communications Hldgs Capital Goods $9,873 55% 12% (NYSE:MCK)  Mckesson Corp Health $16,880 43% 12% (NYSE:PFE) Pfizer Inc Health $148,488 17% 11% (NYSE:MO)  Altria Group Inc Consumer Non Durable $40,753 1693% 20% (NASDAQ:CEPH) Cephalon Inc Health $4,414 32% 12% (NYSE:OMC)   Omnicom Group Inc Consumer Services $11,681 -178% 10% (NYSE:DO) Diamond Offshre Drilling Capital Goods $13,503 37% 14% (NYSE:LLY)  Eli Lilly & Co Health $40,928 47% 15% (NYSE:SNI) Scripps Networks Intr In Consumer Services $6,692 77% 10% (NASDAQ:BIIB) Biogen Idec Inc Health $14,133 46% 11% (NYSE:FRX)  Forest Laboratories Inc Health $9,563 22% 13% (NYSE:RTN)  Raytheon Co Capital Goods $20,479 67% 14% (NYSE:DPS) Dr Pepper Snapple Grp Consumer Non Durable $7,131 71% 10% (NYSE:HRS) Harris Corp Technology $5,964 57% 11% (NYSE:MHP) Mcgraw-Hill Co Inc Consumer Services $10,886 129% 11% (NYSE:FLR) Fluor Corp Capital Goods $7,252 46% 20% (NYSE:LH)  Laboratory Cp Am Hldgs Health $7,961 108% 10% (NYSE:LH)  Moody'S Corp Consumer Services $6,281 -2400% 9% (NYSE:FLS) Flowserve Corp Capital Goods $5,398 40% 11% (NYSE:GME) Gamestop Corp Cl A Consumer Services $3,671 69% 17%

 

 Click Here - If you are a professional investor and would like a review of your portfolio by an AFG representative or to discuss companies AFG find attractive that fit your investment style.

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To identify potentially attractive investment ideas, The Applied Finance Group (AFG) usually uses a combination of proprietary variables to develop a focused group of potential buy ideas that meet criteria based on valuation, economic performance, management quality, and earnings quality. Although this set of investment criteria has proven successful in generating buy ideas, AFG’s valuation on a standalone basis has consistently been able to identify mispriced securities and investment opportunities that outperform their chosen benchmark.

Several times over the last year ValueExpectations.com has released lists of companies narrowed only by the valuation properties of the company using AFG’s Value Score (defined below). Today, we will revisit these blog posts and compare the performance results of the companies previously identified to the results of their benchmarks.

Below is an update of the performance of the articles we have released where companies were identified by using AFG's valuation metric as the sole variable. Included in this table is the blog portfolio's performance, the performance of the index, and the spread relative to the index. The performance of all portfolios and their benchmarks are tracked from the date of the blog's release until last Friday's close. As you can see in the table below, companies identified by AFG as having an attractive valuation have performed quite well and have consistently outperformed their benchmarks.

If you are a professional investor and would like to better understand and access AFG's valuation metric to review your portfolio - Click Here

 

Below is an updated list of the S&P 500 companies with the most attractive valuations according to AFG’s valuation model including Freeport McMoran C&G (NYSE:FCX) and Fluor Corp. (NYSE:FLR).

To stay updated on companies AFG believes are attractive investment opportunities register for ValueExpectations.com It's Fast and Free!

AFG Investment Rank within Sector Ticker Name Sector  Opportunity Valuation Signal  Cheapest Stocks In The S&P 500 (NYSE:FCX)  FREEPORT-MCMORAN C & G Basic Material Attractive Attractive (NYSE:WAT)  WATERS CORP Capital Goods Attractive Attractive (NYSE:FLR)  FLUOR CORP Capital Goods Attractive Attractive (NYSE:TAP)  MOLSON COORS BREWING CLB Consumer Non Durable Attractive Attractive (NYSE:CL) COLGATE-PALMOLIVE CO Consumer Non Durable Attractive Attractive (NYSE:DNB) DUN & BRADSTREET CORP Consumer Services Attractive Attractive (NASDAQ:BIIB) BIOGEN IDEC INC Health Attractive Attractive (NYSE:PFE) PFIZER INC Health Attractive Attractive (NYSE:BMY)  BRISTOL-MYERS SQUIBB CO Health Attractive Attractive (NYSE:IBM) INTERNAT BUSINESS MACHNS Technology Attractive Attractive

 Click Here - If you are a professional investor and would like a review of your portfolio by an AFG representative or to discuss companies AFG find attractive that fit your investment style.

Applied Finance Group’s (AFG’s) Value Score defined - 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.

To stay updated on companies AFG believes are attractive investment opportunities register for ValueExpectations.com It's Fast and Free!

The Applied Finance Group’s (AFG’s) goal is to help its clients pick the best stocks in any index, sector or market cap through the use of its Economic Margin (EM) methodology, valuation techniques, and ability to evaluate management’s capability to create shareholder wealth. The EM methodology helps investors understand the true economic profitability a company has earned by making adjustments to correct for some of the common distortions in traditional GAAP accounting practices. The valuation model AFG has built has proven through time to identify mis-priced securities which helps its clients take advantage of those mis-pricings and outperform their chosen benchmark (most commonly the S&P 500).

Below is a list of companies from the S&P 500, one from each major AFG sector (Excluding Financials), that meet AFG’s criteria to be considered as an attractive investment opportunity based on expected improvement in EMs, attractive valuation and a management team following a wealth creating strategy.

AFG Rank within Sector Ticker Name Sector Investment Opportunity Valuation Signal EM Change Signal Attractive  S&P 500 Companies (NYSE:WAT) WATERS CORP Capital Goods Attractive Attractive Positive (NYSE:HAS)  HASBRO INC Consumer Durable Attractive Attractive Positive (NYSE:LO)  LORILLARD INC Consumer Non Durable Attractive Attractive Positive (NYSE:DRI)  DARDEN RESTAURANTS Consumer Services Attractive Attractive Positive (NYSE:ABT) ABBOTT LABORATORIES Health Attractive Attractive Positive (NASDAQ:FISV)  FISERV INC Miscellaneous Attractive Attractive Positive (NASDAQ:SYMC)  SYMANTEC CORP Technology Attractive Attractive Positive

Investors are always looking for an edge, a way to improve their stock selection process in the hope that it improves their overall performance. Fundamental investors may flirt with the idea of adding a technical overlay to their process while a value investor may take more of a chance on a growth company. No matter what style of investor you are, you want to be sure the process you are implementing makes sense.

Because of the volatility of the market, investors seem to be paying more attention to the technicals of the companies they hold or are considering to buy. While there are several ways technical analysts look at the momentum in the market, ValueExpectations.com will concentrate on the simple, yet widely used 50 and 200 day moving averages relative to a companies current trading price.

We, at The Applied Finance Group (AFG), believe that technicals are relevant, but it is much more important to focus on the fundamentals of a company in determining which securities are over/under valued. We have taken the S&P 500 and focused only on the stocks trading above their 50 and 200 day moving averages (44%) for those investors who pay closer attention to technicals, and provided a list of companies in most of the major economic sectors that we find attractive and some that we find unattractive based on AFG’s investment criteria, which focuses more on valuation attractiveness and expected corporate performance.

However, if you do look at momentum, a variable we would suggest concentrating on is economic momentum. AFG’s economic momentum coupled with valuation give you a tremendous advantage in outperforming!

		AFG	Rank within Sector
Ticker	Name	Investment Opportunity	Valuation Signal	EM Change Signal
Capital Goods - Attractive
(NYSE:RDC)	ROWAN COMPANIES INC	Attractive	Attractive	Positive
(NYSE:DO)	DIAMOND OFFSHRE DRILLING	Attractive	Attractive	Positive
Capital Goods - Unattractive
(NYSE:SWK)	STANLEY WORKS THE	Unattractive	Unattractive	Negative
(NYSE:LEN)	LENNAR CORP CL A	Unattractive	Unattractive	Negative
Consumer Durable - Attractive
(NYSE:OI)	OWENS ILLINOIS INC	Attractive	Neutral	Positive
(NYSE:XRX)	XEROX CORP	Attractive	Attractive	Neutral
Consumer Durable - Unattractive
(NYSE:IGT)	INTERNAT GAME TECHNOLOGY	Unattractive	Unattractive	Negative
(NYSE:HAR)	HARMAN INTERNAT IND INC	Unattractive	Unattractive	Negative
Consumer NonDurable - Attractive
(NYSE:LO)	LORILLARD INC	Attractive	Attractive	Positive
(NYSE:CL)	COLGATE-PALMOLIVE CO	Attractive	Attractive	Positive
Consumer NonDurable - Unattractive
(NYSE:RL)	POLO RALPH LAUREN CORP	Unattractive	Unattractive	Negative
(NYSE:HNZ)	H.J. HEINZ CO	Unattractive	Unattractive	Negative
Consumer Services - Attractive
(NYSE:DRI)	DARDEN RESTAURANTS	Attractive	Attractive	Positive
(NYSE:EFX)	EQUIFAX INC	Attractive	Attractive	Positive
Consumer Services - Unattractive
(NYSE:HOT)	STARWOOD HTLS & RSRTS WW	Unattractive	Unattractive	Negative
(NYSE:CBS)	CBS CORP CL B	Unattractive	Unattractive	Negative
Health - Attractive
(NASDAQ:BIIB)	BIOGEN IDEC INC	Attractive	Attractive	Positive
(NYSE:PFE)	PFIZER INC	Attractive	Attractive	Positive
Health - Unattractive
(NASDAQ:MYL)	MYLAN INC	Unattractive	Unattractive	Negative
(NASDAQ:ISRG)	INTUITIVE SURGICAL INC	Unattractive	Unattractive	Negative
Technology - Attractive
(NASDAQ:SYMC)	SYMANTEC CORP	Attractive	Attractive	Positive
(NYSE:HRS)	HARRIS CORP	Attractive	Attractive	Positive
Technology - Unattractive
(NASDAQ:LLTC)	LINEAR TECHNOLOGY CORP	Unattractive	Unattractive	Negative
(NASDAQ:CIEN)	CIENA CORP	Unattractive	Unattractive	Negative
Utilities - Attractive
(NYSE:PEG)	PUBLIC SVC ENTPRS GROUP	Attractive	Attractive	Positive
(NYSE:D)	DOMINION RESOURCES VA	Attractive	Attractive	Positive
Utilities - Unattractive
(NYSE:NI)	NISOURCE INC	Unattractive	Unattractive	Negative
(NYSE:NU)	NORTHEAST UTILITIES	Unattractive	Unattractive	Negative

 

Sectors without adequate representation were excluded (Financials, Basic Material, Transportation)

When analysts and market pundits come on tv to talk about stock picks, they usually talk about the "P/E" ratio (Price to Earnings) being attractive.  However if you're investing in stocks and you only look at the "P/E" ratio, you might be walking into a "Value Trap".  Investors ignore half the valuation picture when investors only concentrate on P/E as investors also need to consider the growth potential of the company and what investments are needed to get the earnings.  The Applied Finance Group (AFG) has developed a process that incorporates these factors easily into the valuation framework.  Using AFG’s Valuation Metric, we have compiled a list of 20 companies with low P/E, 10 of which we consider attractive investments, and 10 of which we consider Value Traps.

By using AFG's Economic Margin framework instead of earnings alone, investors capture the true net cash flow the entire firm is generating. It is not uncommon for companies to grow P/E while having declining EM’s. This occurs when the cost for the investment required to yield the increasing P/E is more than the cash flow generated from the investment. By analyzing a company’s EMs through time, investors gain a more accurate account of levels and changes in a company’s current profitability and value.

If earnings are a true proxy for performance, there should be a correlation between a company growing earnings and its price to earnings ratio. As a surprise to many investors, there is actually little to no correlation between earnings growth and price to earnings ratios (see chart below).
 

P/E is determined by taking a stock’s price and dividing it by the last four quarter’s worth of earnings. P/E alone should not be used to value companies. P/E does not look at a company’s balance sheet thus we do not know what the costs of generating those earnings. While the P/E is determined by looking at a company’s past performance, EM bases a company’s value off its future projections. By using EM, an investor can know how their stocks are likely to perform, allowing them to clearly evaluate where to invest.

Successful companies measure results, make decisions and set strategy with the goal of creating value. A company’s performance measures must serve as a proxy for its market value creation. While important, S-T Earnings alone are a poor indicator of a company’s value, due to what they do not measure.
 

Economic Margin is a more complete performance measure for companies to use to guide performance and motivate employees. Executives consider Cash Flow, Investment, Competition & Risk when setting strategy. The above charts show that investors do the same.

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.

Investment Insights from your peers, Professional Investors - The Applied Finance Group would 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. 
Click here to learn more

The Applied Finance Group’s (AFG’s) Economic Margin (EM) methodology helps investors understand what a company earns above its true cost of capital or how profitable a firm is. Companies expected to improve their Economic Margins have proven to be more likely to outperform than companies with expected EM declines. The table below provides 10 stocks expected to improve their Economic Margins in the next fiscal year and look attractive from a valuation perspective according to AFG’s valuation model. All 10 of these firms also currently have a default buy recommendation and look to have considerable long-term upside.

S&P 500 - Stocks to Watch (ex. Financials)

 

AFG's default valuation is a great place to start when looking for potential equity investments as 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.

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.

All companies listed below met The Applied Finance Group's (AFG's) Buy screen criteria 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.

 

9 Value Companies To Watch

A brief description of AFG's buy criteria variables:

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.
AFG's Value Universe - Companies in the AFG universe, which have MV/IC at the bottom 50% of the universe and have EPS estimates.

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

In life, the most attractive people are in shape and have good looks, just look at Hollywood. The same is true the majority of the time in investing. The most attractive stocks have healthy financial statements and look good from a valuation standpoint.

The Altman Z-score is a metric that gives insights into the likelihood of a firm going bankrupt in the next 2 years. The model was developed by Professor Edward I. Altman of the NYU’s Stern School of Business and first published in The Journal of FINANCE in September 1968. A common critique to this metric is that it was developed over 40 years ago and is no longer relevant.

In 2001, Professor Joseph D. Piotroski of The University of Chicago Graduate School of Business, published a paper called, Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers. Piotroski showed that value investors were rewarded by looking at a firm’s financial health and he showed that Z-score was a meaningful statistic.
More recently, on December 5, 2008, Dr. Altman was called to testify before a House of Representatives Committee on the condition of U.S. Automakers. In his testimony, he noted that Bloomberg, Inc. reported, “that approximately 1,000 users of their system per day access the Altman Z-Score model.”

The Altman Z-Score breaks down firms into 3 zones:
• >2.99 – Not Likely to Go Bankrupt
• 1.8 - 2.99 – Gray Area
• <1.8 – Likely to Go Bankrupt in the Next 2 Years

Using AFGView.com, we screened for firms that looked relatively attractive from a valuation perspective and had an Altman Z-Score above 2.99. Below is a list of those firms. Later we will look at firms that are expensive and have a Z-Score below 1.8.

Sales Expectations for Companies with an Attractive Valuation and Healthy Balance Sheet

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