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Capital Goods Sector Overview – Including Fluor Corp (NYSE:FLR)
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Magic Formula Screen… Magical Returns?? – Including National Oilwell Varco (NYSE:NOV) and Lorillard Inc (NYSE:LO)
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.
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.
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Attractive Large-Cap Opportunities – Including Kohl’s Corp. (NYSE:KSS) Whirlpool (NYSE:WHR) and Colgate-Palmolive (NYSE:CL)
The Applied Finance Group (AFG) has a disciplined approach for identifying companies that are expected to outperform and underperform the market by using proprietary metrics and measurements that have been tested and proven through time. Because AFG’s research is fundamentally derived, AFG’s quantitative analysis spans across growth and value stocks, all sectors, industries, and market caps with over 20,000 covered securities globally.
When searching for Large-Cap ideas, AFG’s Buy/Sell list is a good starting place as it has proven to create a significant spread in performance between companies that come up on AFG’s buy list and those on the sell list. Further focusing on companies based on AFG’s proprietary screening criteria (Economic Margin, valuation, quality of earnings, and management’s ability to create shareholder wealth) will save investors time in their research process. The result is a target group of stocks that can help you outperform as well as identify potential torpedoes to avoid in your portfolios.
Below is a list of attractive companies in the S&P 500 from each major AFG sector (excluding financials). It serves as a focus list of companies for investors to begin with as they meet AFG’s criteria to be an attractive opportunity. They are more likely to outperform their sector peers and the S&P 500, the benchmark that AFG’s clients most often compare themselves with.
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Source: EconomicMargin.com
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.
+View our List of Value Expectations Recommended Articles
AFG Recommendation Performance
9/1998 – 5/2009
Annualized Returns
Source: AFGView client databases from 9/1998 – 5/2009
Universe size: 4,000 to 5,500 firms
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As the Dollar Weakens Buy S&P 500 (INDEXSP:.INX) Stocks With Foreign Exposure
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.
| Attractive Companies In The S&P with High Foreign Sales | ||||
| Ticker | Name | Foreign Sales % | EM Signal | Valuation Signal |
| AES | AES CORP THE | 82.9185 | Positive | Positive |
| CL | COLGATE-PALMOLIVE CO | 76.7004 | Positive | Positive |
| SE | SPECTRA ENERGY CORP | 71.9551 | Positive | Positive |
| GLW | CORNING INC | 70.8978 | Positive | Positive |
| HPQ | HEWLETT-PACKARD CO | 68.7979 | Positive | Positive |
| TAP | MOLSON COORS BREWING CLB | 68.4812 | Positive | Positive |
| DOW | DOW CHEMICAL CO THE | 67.9052 | Positive | Positive |
| CVX | CHEVRON CORP | 67.6507 | Positive | Positive |
| WU | WESTERN UNION CO THE | 66.6793 | Positive | Positive |
| DO | DIAMOND OFFSHRE DRILLING | 59.2788 | Positive | Positive |
| IBM | INTERNAT BUSINESS MACHNS | 58.6122 | Positive | Positive |
| PFE | PFIZER INC | 57.688 | Positive | Positive |
| FCX | FREEPORT-MCMORAN C & G | 57.2432 | Positive | Positive |
| EBAY | EBAY INC | 53.5258 | Positive | Positive |
| XRX | XEROX CORP | 50.4819 | Positive | Positive |
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!!
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Identifying Large Cap Investment Opportunities - Including McDonalds (NYSE:MCD) Sprint (NYSE:S) and Hasbro (NYSE:HAS)
The Applied Finance Group (AFG) has a disciplined approach for identifying companies that are expected to outperform and underperform the market by using proprietary metrics and measurements that have been tested and proven through time. Because AFG’s research is fundamentally derived, AFG’s quantitative analysis spans across growth and value stocks, all sectors, industries, and market caps with over 20,000 covered securities globally. Using AFG’s proprietary criteria, AFG publishes a monthly buy/sell list to provide clients with a refined focused list as a starting point for potential investments. AFG clients can then use Value Expectations to further analyze the expectations embedded in a security’s price and to build out their own model to refine an intrinsic value of a company based on their own expectations.
When searching for Large-Cap ideas, AFG’s Buy/Sell list is a good starting place as it has proven to create a significant spread in performance between companies that come up on AFG’s buy list and those on the sell list. Further focusing on companies based on AFG’s proprietary screening criteria (Economic Margin, valuation, quality of earnings, and management’s ability to create shareholder wealth) will save investors time in their research process. The result is a target group of stocks that can help you outperform as well as identify potential torpedoes to avoid in your portfolios.
Below is a list of attractive and unattractive companies in the S&P 500 from each major sector (as defined by AFG). It serves as a focus list of companies for investors to begin with as they meet AFG’s criteria. They are more likely to outperform their sector peers and the S&P 500, the benchmark that AFG’s clients most often compare themselves with.
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Source: EconomicMargin.com
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.
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Stocks Trading Above 50 and 200 Day Moving Averages (S&P 500)
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 |
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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)
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Financially Healthy Stocks With Attractive Valuations
Value Expectations teaches professional investors how to make more informed investment decision evaluating stocks on the basis of corporate performance, valuation, management quality, earnings quality, and other proprietary variables. These variables inevitably help identify companies that are potential long-term investments while avoiding potential torpedoes. However, during the financial crisis, leverage and a week balance sheet played a significant part when investors evaluated a holding.
To help our institutional clients navigate the environment The Applied Finance Group (AFG) developed the risk analysis template specifically to model the healthiness of a company’s balance sheet. In addition to the risk analysis template we also developed a template that calculated an Altman Z-Score developed to identify companies that are most likely to go bankrupt.
As professional investors we often move on and like to forget the past concentrating on how to gain alpha in the future. However, not to forget the past we decided to post an update list in the S&P500 on companies that are financially healthy and are attractively priced using The Applied Finance Groups valuation model.
Provided below is a list of healthy Z-score companies within the S&P 500 that also look attractive based on The Applied Finance Group’s (AFG’s) investment criteria. All of the companies listed have an attractive valuation and are expected to improve their Economic Margins (AFG’s measure of what a company earns above its cost of capital) more than their sector peers. Companies expected to improve their Economic Margin’s (EMs) have proven to be more likely to outperform than companies with an expected decline in EMs.
Using AFG’s valuation model on AFGView.com, we identified a few 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.
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About The Altman Z-score - 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.
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
Related Tickers: "NYSE:PCP"
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P/E (Price to Earnings) - Value Plays or Value Traps
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
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Stocks To Own If Obama/McCain Won Presidential Election
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.
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Hot Stocks for 2009
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?
AFG Market Forecast Project
Insights From
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
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Recession Proof Your Portfolio
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
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