ERTS

Twice in 2009, ValueExpectations.com highlighted “Fidelity’s Low Priced Stock Fund”, an investment strategy that has been employed since 1989 by fund manager Joel Tillinghast. The theory behind this “low-price” strategy is that stocks within the small cap space tend to experience the most frequent mis-pricings and have the least amount of analyst coverage. Mr. Tillinghast created this strategy to take advantage of the numerous inefficiencies in small caps. They started out as a strategy to invest in stocks trading below $10; that limit has since been raised to $35 to widen the pool of investable stocks. Since the prior 2 stock lists that we previously provided have outperformed, we will once again provide our readers a list of 30 attractive stocks under $35.

Investors who use The Applied Finance Group’s (AFG’s) research and suite of investment tools have the ability to easily understand a company’s true economic profitability, as well as if the company’s asset management policy is suitable to maximize that profitability.

A company that earns above its cost of capital (positive Economic Margins) and is growing its asset base is considered to be following a wealth-creating strategy. Backtests have proven these companies to be more likely to outperform those companies following a wealth-destroying strategy (negative Economic Margins and growing assets). Avoiding firms with management teams who try to grow a negative profitability business has helped our clients since 1996 avoid potential torpedoes in the market. AFG believes that if a firm is not profitable, it needs to divest losers and focus on its core competencies to get its profitability levels back on track and earn the right to grow, rather than throw more money at a losing business. After getting an understanding of how profitable a firm is and which direction the firm’s profitability is headed, investors must then understand how much a company is growing out its assets to take advantage of its current profitability or what to divest in order to fix its profitability.

Beyond having positive Economic Margins (EMs) and growing assets, investors want to see a company improve its EMs at a greater rate than its sector peers, as these companies have also proven to be more likely to outperform than companies with declining EMs. AFG’s Wealth Creation Report (WCR) allows you to visually analyze a company’s historical EM level, current EM and expected change in EM based on projections built out by AFG’s default valuation model, which takes into account the total cash flow a company delivers.

Below are a few examples of companies AFG considers to be following wealth-creating or wealth-destroying strategies, identified by using AFG’s Wealth Creation Report.

Best Buy: Consistent Wealth Creator

Amphenol Corp: Consistent Wealth Creator

Cognizent Technology Solutions: Consistent Wealth Creator

Southwest Airlines: Consistent Wealth Destroyer

Micron Technology: Consistent Wealth Destroyer

Electronic Arts: Growth at the expense of its Economic Margins (Wealth Destroyer)

 

AFG's Wealth Creation Report is a 3 part chart :

The first chart is a summary of a company’s economic performance over time, as well as insight into how analyst EPS forecasts project AFG’s default EMs over the next two years.

• EM – Productive Capital = (Cash Flow minus Capital Charge excluding Intangibles) divided by the

Inflation Adjusted Productive Capital.

• EM – Invested Capital = (Cash Flow minus Capital Charge including Intangibles) divided the by

Inflation Adjusted Productive Capital.

•Val Score = Ranked Percent To Target for the current calendar yr. where 100 is the most undervalued

and 0 is the most overvalued (ranked across all firms in database with forecasts for 4,000 firms).

• EM Chg = One year out forecast EM minus last reported fiscal year's EM. Invested Capital EM is used.

The second part of the chart is the Asset Growth chart allows additional insight not only the growth of a company, but how that company’s growth strategy has affected their economic performance.

 • Assets – Steady Growth (1 Yr) = The real growth rate at which a firm can increase its capital base

given internally generated cash, while maintaining a constant capital structure.

• Assets – Actual Growth (1 Yr) = Real year over year change in Inflation Adjusted Invested Capital

achieved by the firm. Note: All actual growth is “actual”, i.e. 2007 growth represents growth from most

recent quarterly balance sheet.

This data can then be used to identify how the stock has performed in relation to the market place.

• Return Net Market = The company's cumulative total return relative to the cumulative market-weighted

average total return of the largest 2000 companies for the equivalent time period.

 

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.

Company Descriptors Sales Growth   Ebitda   Asset Turnover Exchange/Ticker Name Sector "Priced-in" Sales Growth 5 Year Median LFY   5 Year Median LFY   5 Year Median LFY (NYSE:ABT) ABBOTT LABORATORIES Health 6.32% 13.51% 13.94%   25.34% 24.83%   0.69 0.70 (NYSE:AEP)  AMERICAN ELECTRIC POWER Utilities 9.53% 4.22% 7.92%   27.14% 28.82%   0.33 0.32 (NYSE:AES)  AES CORP THE Utilities -4.73% 12.73% 18.27%   34.66% 29.23%   0.39 0.46 (NASDAQ:APOL) APOLLO GROUP INC CL A Miscellaneous -2.48% 15.31% 15.31%   28.46% 25.59%   1.71 1.69 (NYSE:AZO) AUTOZONE INC Consumer Services -8.92% 3.72% 5.72%   19.59% 19.72%   1.33 1.24 (NYSE:BIG)  BIG LOTS INC Consumer Services 15.47% 1.25% -0.24%   5.44% 6.86%   2.74 3.24 (NYSE:BMY)  BRISTOL-MYERS SQUIBB CO Health -1.23% -0.89% 6.46%   24.98% 22.84%   0.70 0.70 (NYSE:BSX)  BOSTON SCIENTIFIC CORP Health 5.14% 11.72% -3.67%   28.70% 27.68%   0.45 0.30 (NYSE:CAG)  CONAGRA FOODS Consumer Non Durable 23.23% 0.31% 9.70%   11.31% 10.74%   1.02 1.15 (NASDAQ:CEPH)  CEPHALON INC Health -5.73% 19.35% 11.40%   26.65% 26.37%   0.47 0.62 (NYSE:DNB) DUN & BRADSTREET CORP Consumer Services -18.53% 4.43% 7.95%   30.41% 32.09%   0.93 1.09 (NYSE:DPS)  DR PEPPER SNAPPLE GRP Consumer Non Durable 15.11% 10.36% -0.66%   20.60% 20.60%   0.55 0.66 (NYSE:DRI)  DARDEN RESTAURANTS Consumer Services -1.78% 8.38% 8.92%   13.02% 12.80%   1.80 1.44 (NASDAQ:ERTS) ELECTRONIC ARTS INC Technology 2.34% 5.81% 14.93%   10.99% -2.24%   0.69 0.90 (NYSE:FIS) FIDELITY NATIONAL INFO Consumer Services -7.42% 7.47% -27.57%   23.50% 26.76%   0.83 0.46 (NASDAQ:FISV)  FISERV INC Miscellaneous 14.41% 11.94% 20.83%   22.99% 23.53%   0.48 0.51 (NYSE:HAS)  HASBRO INC Consumer Durable 2.47% 3.01% 4.79%   16.31% 17.62%   1.00 1.27 (NYSE:HRS)  HARRIS CORP Technology -1.48% 19.14% -5.76%   15.24% 15.96%   1.13 1.12 (NYSE:KR)  KROGER CO THE Consumer Services 4.51% 7.30% 8.21%   5.31% 5.21%   3.04 3.27 (NYSE:LO)  LORILLARD INC Consumer Non Durable -5.09% 5.62% 5.92%   33.08% 32.55%   1.44 1.81 (NYSE:NOC)  NORTHROP GRUMMAN CORP Capital Goods 1.10% 5.84% 5.84%   9.99% 11.63%   0.92 1.12 (NYSE:PEG)  PUBLIC SVC ENTPRS GROUP Utilities 7.72% 3.65% 3.65%   24.57% 30.23%   0.42 0.46 (NYSE:PFE)  PFIZER INC Health -4.75% -0.25% -0.25%   40.22% 32.09%   0.42 0.43 (NYSE:PM) PHILIP MORRIS INTL INC Consumer Non Durable 18.90% -10.87% -53.35%   18.26% 17.37%   1.78 0.78 (NYSE:RDC)  ROWAN COMPANIES INC Capital Goods -20.68% 38.68% 5.62%   33.16% 38.76%   0.40 0.49 (NYSE:S)  SPRINT NEXTEL CORP Technology -13.65% 18.30% -11.24%   29.59% 25.61%   0.62 0.61 (NYSE:SEE)  SEALED AIR CORP Basic Material -3.95% 7.47% 4.13%   16.64% 15.47%   0.85 0.97 (NYSE:STZ)   CONSTELLATION BRANDS INC Consumer Non Durable 23.76% 12.62% -3.14%   17.06% 16.97%   0.54 0.45 (NASDAQ:SYMC)  SYMANTEC CORP Technology 6.36% 25.49% 4.69%   30.39% 27.15%   0.37 0.58 (NYSE:TAP)  MOLSON COORS BREWING CLB Consumer Non Durable 14.61% 6.14% -22.88%   17.95% 17.83%   0.49 0.46 (NYSE:TMO)  THERMO FISHER SCIENTIFIC Health 7.08% 19.36% 7.71%   14.90% 18.20%   0.56 0.50 (NYSE:TSO)  TESORO CORPORATION Energy and Extraction -47.31% 29.18% 29.18%   6.76% 6.19%   3.04 3.81 (NYSE:VZ) VERIZON COMMUNICATIONS Technology 2.94% 5.37% 4.16%   32.18% 32.05%   0.46 0.48 (NYSE:WAT)  WATERS CORP Capital Goods 5.94% 10.53% 6.93%   28.15% 27.30%   0.80 0.97

Fidelity has a fund called the Low Priced Stock fund that only contains stocks with a price of below $35 a share which has been successful in the past. Following a similar strategy ValueExpectations.com has published 2 articles containing attractive stocks under $35 as a starting place for investor’s looking for potential investment opportunities. The first low priced stock strategy blog outpaced the S&P 500 by over 58% since release in February the second article released in June has slightly underperformed the S&P 500 by -1.26%. Since this strategy has been well received by VE readers we decided to provide a new list of attractive stocks using the same strategy.  Below is a list of S&P500 stocks that are currently trading under $35 a share that have passed through AFG’s investment criteria which looks for companies ranked in the top half of their sector in valuation, economic performance, management quality and earnings quality. All of the companies listed scored well in all of the required variables for AFG to deem a company attractive and backtests will show that all of these variables deliver a significant spread in performance between those that AFG sees as unattractive vs. those that look attractive from an AFG standpoint.  To analyze your holdings using AFG’s research process click here.

AFG Rank within Sector Ticker Name Sector Investment Opportunity Valuation Signal EM Change Signal   (NYSE: BMY) BRISTOL-MYERS SQUIBB CO Health Attractive Attractive Positive (NYSE: HRS) HARRIS CORP Technology Attractive Attractive Positive (NYSE: AEP) AMERICAN ELECTRIC POWER Utilities Attractive Attractive Positive (NYSE: VZ) VERIZON COMMUNICATIONS Technology Attractive Attractive Positive (NASDAQ:ERTS)  ELECTRONIC ARTS INC Technology Attractive Attractive Positive (NYSE:STZ)  CONSTELLATION BRANDS INC Consumer Non Durable Attractive Attractive Positive (NYSE:BSX)  BOSTON SCIENTIFIC CORP Health Attractive Attractive Positive (NYSE:SEE)  SEALED AIR CORP Basic Material Attractive Attractive Positive (NYSE:CAG) CONAGRA FOODS Consumer Non Durable Attractive Attractive Positive (NYSE:BIG) BIG LOTS INC Consumer Services Attractive Attractive Positive

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.

When identifying possible sell/short opportunities (torpedoes) The Applied Finance Group (AFG) starts by running a screen using its proprietary Sell Criteria variables starting with Economic Margin. Economic Margin is a  measure of corporate performance that identifies how profitable a company is by measuring how much the company earns above or below its cost of capital. In addition to corporate performance, AFG looks to identify those companies that are attractively priced using our valuation model. Lastly AFG evaluates how well companies run their business using its Management Quality score, eliminating companies that have management teams that destroy wealth.

The 9 firms listed below all meet AFG’s Sell Criteria. In addition, these companies all earn less than their cost of capital which means they earn a negative Economic Margin and only 3 (ERTS, MOLX, SWK) have a Z-Score (Altman Z-Score) that were not in the at-risk range. AFG has a track record of identifying winners and losers in the market.

If any of these firms are holdings in your portfolio, pay extra attention to these companies as they contain all of the characteristics of a bad investment and may be a potential torpedo lurking in your portfolio. AFG has proven successful since 1996 at identifying good companies as well as sell opportunities, providing a solid buy/sell spread.

 

Potential Torpedoes (S&P 500)

The Applied Finance Group (AFG) works with some of the most well respected investment firms in the U.S. to help them develop quantitative screening processes to identify a better fishing pond of companies to choose from for their portfolio holdings. However, picking winning investment opportunities isn’t the only value add AFG provides clients. They also develop quantitative strategies to quickly identify possible torpedoes lurking in your client or prospective client’s portfolio.

AFG’s quantitative process is centered on their proprietary Economic Margin Framework. The core of AFG’s quantitative process starts with evaluating corporate performance and the expected improvement relative to their peers, evaluating the valuation attractiveness of the company, and determining if a firm is following a wealth creating or wealth destroying strategy.

A brief description of those variables are 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 their peers.

Management Quality – Access management’s ability to make wealth creating decisions.

When identifying torpedoes AFG looks for companies with the least valuation upside compared to their sector peers, below sector median expected Economic Margin change, and a management quality score that reflects a management team following a wealth destroying strategy.

These 16 S&P 500 companies are potential torpedoes that could be lurking in your portfolio. These companies all possess characteristics that make for a bad investment opportunity. If you own one of these companies and would like a more in-depth explanation of why they are considered a potential torpedo, please email support@afgltd.com.

 

S&P 500 Potential Torpedoes

*AFG’s Value Expectation interface allows us to understand the imbedded Sales Growth, EBITDA Margins, and Asset Turnovers 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 above table displays the implied future sales growth of these mining companies assuming their EBITDA margins and Asset turnovers stay at the 5 year median levels.