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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.

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.

By using The Applied Finance Group’s (AFG's) Risk Analysis, we have identified the top and bottom two firms in each sector (excluding the Financial sector) according to an overall risk score based on 9 variables (see more detail below). In addition to the risk analysis variables we also added another layer of analysis by evaluating the companies’ Earnings Quality (based on the concept of Accruals) and Altman Z-Score (identifies firms that are at risk of going bankrupt in the next 2 years).

Applied Finance Group’s Risk Analysis is designed to systematically calculate a stock’s risk score based on fundamental relationships between the Quarterly Income Statements and Balance Sheets. The template measures 9 factors to determine Risk: Changes in A/R, Changes in Inventories, Cash Flow vs. Operating Cash Flow, Fixed Payments vs. Pre-Tax Cash Flow, Leverage, Intangibles, Write-offs, Management Quality, and Valuation. Companies with lower scores have less risk. Companies in the Financial Sector were excluded due to their differences in financial statement structure.
 

1. Receivables to Sales - Delta – takes the difference in the median A/R to Sales ratio over the last 4 quarters vs. median 4 quarters before that.

2. Inventories to Sales - Delta – takes the difference in the median Inventories to Sales ratio over the last 4 quarters vs. median 4 quarters before that.

3. AFG’s Cash Flow-Oper. vs. Operating Cash Flow - AFG's Cash Flow-Oper. for a company is net cash that is generated by the continuing and discontinuing operations of the firm. We compare it to the company's Operating Cash Flow to assess its ability to pay its debt.

4. Fixed Payments vs. Pre-tax Payments Cash Flow – This ratio assesses the company’s ability to cover long-term obligations. If the fixed pmts are greater than 50% of the pre-tax payments cash flow, there is chance that this company may not be able to meet its obligations. Obligations less than 30% of cash flow are considered safe.

5. Leverage – Book leverage and Market leverage are analyzed to give us information about the company’s leverage position. Best score is given to the companies with Book Leverage lower than 60%, and negative score to these with Book Leverage higher than 60% and Market Leverage greater than 0.9*Book Leverage.

6. Intangibles as a Percentage of Total Assets – With this score we try to filter through and reward the companies that have grown organically, rather than through acquisitions. Our research has shown that on average companies tend to overpay for acquisitions and thus are rarely a profitable investment. Companies with Intangibles less than 20% of Total Assets get the best score.

7. Write-offs – Shows the number of years with significant write-offs over the last 5 years.

8. Management Quality – Measures a company’s EM+1 and LFY Asset Growth and there is empirical evidence that companies with positive EMs that are able to grow their business tend to outperform companies with negative EMs who continue to invest into unprofitable business.

9. Value Score – Measures a company’s attractiveness from valuation perspective.

Most/Least Risky Firms By Sector S&P 500 (excluding financials)

If you are a professional investor and would like to learn more about this analysis as well as other useful valuation tools click here for a free trial subscription to The Applied Finance Group's research.

Below is a look at the YTD returns, valuation attractiveness and sales growth expectations of the two biggest and smallest companies in each sector within the S&P 500 (excluding financials). This link provides some insight into Applied Finance Group’s (AFG’s) valuation techniques. Also compare the expectations for sales growth to what the companies have delivered historically to see which stocks on this list are most likely to meet or exceed those expectations, and thus be more likely to out-perform.

 Biggest/Smallest Companies (Mkt Cap) By Sector S&P 500 (excluding financials)

*AFG’s Value Expectation 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 table displays the implied future sales growth of companies assuming their EBITDA margins and Asset turnovers stay at the 5 year median levels.

Economic Margin is a measure of economic profitability that identifies how much a company earns above or below its cost of capital. We analyzed all companies in the S&P500 Index based on their historical, current and forecasted Economic Margins to see which firms have the best average of past, present and future profitability. We identified the two most profitable and the two least profitable companies from each sector and have presented them in the table below. As a base of reference, the average firm in corporate America earns a 0 (zero) Economic Margin, or is a “break-even business”. Our research has shown that companies with consistently positive EMs that are also expected to increase their EMs in the future tend to outperfom firms with negative or declining EMs.
<!--[if gte mso 10]> Economic Margin is a corporate performance measure, which helps us identify well managed, wealth creating companies. Although not included in this post, we want to remind you that it is also important to understand the attractiveness of corporations' valuations to make sure we invest in great companies at great prices. (Here is an article by ValueExpectations.com explaining Applied Finance Group’s basic valuation concepts).

Note: Only companies in the S&P 500 were included.

S&P 500 Companies With The Best/Worst Average Profitability (Economic Margin)

Economic Margin (EM) Defined: A measure of corporate performance that captures off balance sheet items, by looking at how much a company is earning above or below their cost of capital. EM is expressed in a % or margin. The Economic Margin Framework™ is more than just a performance metric as it encompasses a valuation system that explicitly addresses the four main drivers of enterprise value: profitability, competition, growth and cost of capital. more EM details (PDF)

Fortune magazine recently put out an article listing the most admired companies in the world.  We took the top 50 firms (excluding Financials, and companies not traded in the US) on their list and put them through Applied Finance Group's quantitative recommendation framework.  Just because these firms are among the most admired companies in the world does not qualify them as the most attractive investment. Being among the most admired is an honor and means you must be doing something right, but might not necessarily mean the share price is currently attractive. 

The following articles which we have posted in the past on ValueExpectations.com will give you a better understanding of what it takes for management to create wealth, understand Management Quality, and see how EPS alone falls short in estimating a company’s value. There are two main characteristics a company must have in order to be a good investment opportunity: (1) the company needs to be a strong economic performer, (2) the company should be attractively priced.   Many people admired the DeLorean, but it was neither a good performing car nor a good priced car. Below we reveal a few "DeLoreans" after looking under the hood.

Top 50 Most Admired Companies According to Fortune

Mike Burdi of Applied Finance Group and Drew Morris of Great Numbers recently published a ranking of S&P 500 companies in CEO Magazine Using AFG's Wealth Creation Index. This measure of ranking CEO’s has been gaining traction and receiving publicity in national publications. Below are a few links to articles that have recently been published discussing our methods and results of identifying the biggest wealth creators and destroyers amongst the CEO’s of the nation’s largest companies.

An article written by Pittsburgh Post Gazette highlighting CEO Of Federated

An article from Planebuzz.com highlighting Southwest Airlines CEO

An article explaining the rankings with a link to the article by Directors Daily

An article explaining Economic Margin by New Jersey Star Ledger

The entire article posted on RealClearMarkets.com

The top and bottom CEO's from the rankings below:

Top 5 Companies based on CEO Rank along with Sales Growth Expectations

Bottom 5 Companies based on CEO Rank along with Sales Growth Expectations

Performance Rankings of the Top 50 and Bottom 50 Wealth Creating CEO's

Today we look at a recent article in CEO magazine by Mike Burdi of The Applied Finance Group (AFG) and Drew Morris using AFG’s Wealth Creation Index to rank the top wealth creating and wealth destroying CEO’s within the S&P 500. After comparing the top 5 on each list by using AFG’s valuation techniques and comparing the sales growth expectations built-in to their current price (VE Sales Growth) with what the companies have achieved in the last five years (5 Year Median Sales Growth), it is easy to see that good companies do not always make good investments. AFG’s Value Score measures the stock’s attractiveness relative to the universe based on AFG’s Intrinsic Value Target Price. The score is ranked from 1-100 with 1 being the most overvalued and 100 being the most undervalued stock in the universe. VE sales growth captures the sales growth expectations priced-in to the stock to justify the current price.
Although the top 5 are well run companies, that does not automatically qualify them to be good investments. Depending on what the market has priced-in, and how likely the company can deliver that performance determines whether the company is a good investment or not. Many companies that have been beaten up and even those with wealth destroying CEO’s may be a good investment if very low expectations are priced-in and you feel the company can exceed their expectations.

Top 5 Wealth Creating CEO’s

*denotes company has only 3 years historical sales growth

Top 5 Wealth Destroying CEO’s

VE Sales Growth was calculated for these companies on 12/14/08