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- 25 Best Stocks of 2010, Our take on 2010’s hot stocks – Including Big Lots Inc.(NYSE:BIG), Family Dollar Stores Inc. (NYSE:FDO)
- Monthly Market Review - Where does the market go from here?
- Kraft Foods Inc (NYSE:KFT) acquisition analysis of Cadbury Plc (NYSE:CBY)
- If the health insurers don’t do it, who is going to do it? The Case for Humana Inc. (NYSE:HUM)
- AFG Basic Valuation Concepts
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Hot and Cold Stocks From Every Sector (ex. Financials) - Including Hewlett-Packard Co. (NYSE:HPQ) and Conoco Phillips (NYSE:COP)
Fidelity’s Low Priced Stock Fund: Low Priced Stocks We Like - Walgreen Company (NYSE:WAG) and Microsoft Corp. (NASDAQ:MSFT)
High Value Score Stocks – Including Pfizer Inc. (NYSE:PFE) and Gamestop Corp. (NYSE:GME)
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.
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Professional Investors Like Health Stocks – Including Medco Health Solutions (NYSE:MHS) and McKesson Corp. (NYSE:MCK)
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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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Cheapest Stocks In The S&P 500 – Including Freeport McMoran C&G (NYSE:FCX) and Fluor Corp. (NYSE:FLR)
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.
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).
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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.
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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Most Actively Traded Stocks (S&P 500) – Including Wal-Mart Stores (NYSE:WMT) and Apple Inc. (NASDAQ:AAPL)
The list of most actively traded stocks in the S&P 500 seems to attract the most attention amongst the investment community and always create a good amount of “Buzz”. We decided to take the list of the most actively traded stocks over the last 50 trading days (excluding financials) and run them through The Applied Finance Group’s (AFG’s) meat grinder to see which are worthy of the hype and are attractive investment opportunities and which you should probably stay away from.
AFG uses a set of criteria in its stock selection process that has proven successful at identifying winners and losers in the market including its proprietary measure of corporate performance (Economic Margin), valuation, management quality and earnings quality among other criteria. Of the companies listed that are heavily traded, AFG believes the companies with expected improvement in Economic Margins, attractive valuations, and a wealth creating management team are the companies that will be the most likely to outperform the market and their sector peers. (register now to receive exclusive buy ideas- it's fast and free!)
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The rankings above were provided using AFG’s research product AFGView.com and are ranked based on AFG’s overall investment opportunity signal, valuation signal and expected changes in Economic Margins. The companies must rank as attractive or unattractive in all 3 categories or the firm is listed as neutral.
Below is a brief description of those variables with informative links.
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 Expepectations 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!!
Identifying Buy Ideas Using AFG's Screener Tool - Including Sprint Nextel Corp (S), Pfizer (PFE) and Forest Labs. Inc (FRX)
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!
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Sales Growth Expectations for Attractive S&P 500 Stocks - Including Bristol-Myers Squibb (BMY), Pfizer (PFE) and Sprint (S)
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.
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Solid Value Companies in the S&P 500 - Including Sprint (S), Pfizer (PFE) and Darden Restaurants (DRI)
For those Valueexpectations.com readers who consider themselves value oriented investors, we have provided a good starting list of solid value companies that look attractive as potential investment opportunities for the long term. This list is a good place to start when looking for potential companies to add to your portfolio. The Applied Finance Group (AFG) considers companies with a Market Value/Invested Capital (MV/IC) in the bottom half of the universe as value companies.
To come to our list of attractive potential value plays, We ran those companies in the bottom half of MV/IC through AFG’s buy criteria that includes Economic Margin (How profitable they are), Valuation, Management Quality (how well management is running the business) as well as other quality checks to ensure that these companies are the most likely value companies to outperform. All 10 of these companies ranked above their sector peers in expected improvement of Economic Margins and in valuation attractiveness which has proven to be a good starting point when looking to identify companies likely to outperform their benchmark.
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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 |
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(NYSE:LO) |
LORILLARD INC |
Attractive |
Attractive |
Positive |
(NYSE:CL) |
COLGATE-PALMOLIVE CO |
Attractive |
Attractive |
Positive |
Consumer NonDurable - Unattractive |
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(NYSE:RL) |
POLO RALPH LAUREN CORP |
Unattractive |
Unattractive |
Negative |
(NYSE:HNZ) |
H.J. HEINZ CO |
Unattractive |
Unattractive |
Negative |
Consumer Services - Attractive |
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(NYSE:DRI) |
DARDEN RESTAURANTS |
Attractive |
Attractive |
Positive |
(NYSE:EFX) |
EQUIFAX INC |
Attractive |
Attractive |
Positive |
Consumer Services - Unattractive |
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(NYSE:HOT) |
STARWOOD HTLS & RSRTS WW |
Unattractive |
Unattractive |
Negative |
(NYSE:CBS) |
CBS CORP CL B |
Unattractive |
Unattractive |
Negative |
Health - Attractive |
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(NASDAQ:BIIB) |
BIOGEN IDEC INC |
Attractive |
Attractive |
Positive |
(NYSE:PFE) |
PFIZER INC |
Attractive |
Attractive |
Positive |
Health - Unattractive |
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(NASDAQ:MYL) |
MYLAN INC |
Unattractive |
Unattractive |
Negative |
(NASDAQ:ISRG) |
INTUITIVE SURGICAL INC |
Unattractive |
Unattractive |
Negative |
Technology - Attractive |
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(NASDAQ:SYMC) |
SYMANTEC CORP |
Attractive |
Attractive |
Positive |
(NYSE:HRS) |
HARRIS CORP |
Attractive |
Attractive |
Positive |
Technology - Unattractive |
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(NASDAQ:LLTC) |
LINEAR TECHNOLOGY CORP |
Unattractive |
Unattractive |
Negative |
(NASDAQ:CIEN) |
CIENA CORP |
Unattractive |
Unattractive |
Negative |
Utilities - Attractive |
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(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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Analyzing the Earnings Quality of Companies Set to Report
Understanding the amount of accruals a company has on its books and the quality of its reported earnings is especially important during earnings season, as poor earnings quality companies are more likely to have negative earnings surprises and underperform as a result. With so many companies reporting earnings this week, we wanted to share an analysis of their earnings quality based on The Applied Finance Group’s Earnings Quality score. AFG’s Earnings Quality variable is based on the concept of accruals and is an important indicator, which helps to differentiate between companies with poor and high quality of reported earnings. Watch out for firms with poor EQ score – make sure they are not trying to pad their sales numbers through channel stuffing, for example.
*Source: www.afgview.com
Two ways to approach accruals:
1. Cash Flow Statement
•Difference between Net Income and Cash Flow
2. Balance Sheet
•Change in Net Operating Assets from Period t-1 to t
•Net Operating Asset equals Total Assets Less Cash, Less Non-Debt Liabilities (excl. Minority Interest)
• Our studies show that the Balance Sheet approach is superior to the Cash Flow Statement approach.
• We found the Balance Sheet approach is also easier to expand to international companies.
• Low Accrual companies outperform high accrual companies
Here is a look at how well the Earnings Quality variable works when you split top half vs. bottom half in each sector/style universe.
Source: AFGView client databases from 9/1998 - 5/2009 Universe size: 4,000 to 5,500 firms
Here is a look at an example of a poor Earnings Quality company that has a negative earning surprise and thus underperforms.
Eastman Kodak
• Other Liabilities declined in Q308, leading to high accruals – change in licensing agreement required immediate recognition of deferred revenue.
• Eastman Kodak (EK) subsequently missed earnings in Q408.
• EK’s stock dropped 29% on January 28th, when Q408 earnings were announced.
• EK has underperformed the S&P500 by almost 70% since January 28th.
source: www.economicmargin.com
Companies Reporting Earnings: Week of July 20 (Part 1)
With a major week of earnings right around the corner, we thought it would be useful to our readers to provide an analysis of the companies set to report in the first half of next week. This analysis contains a breakdown of each company's default recommendation according to AFG's Buy/Sell criteria, a look at their valuation attractiveness, and a look at the direction their Economic Margin's are expected to head in the upcoming year. The three companies that look the most attractive based on these criteria are Pfizer, Advanced Micro Devices and Boston Scientific.
A company's Economic Margin (EM) is a measurement of a their true earnings above or below their cost of capital. EM also corrects distortions caused by accounting policies to give a more accurate assessment of a company's real value. It is important to understand the direction a company's EM's are heading because, by knowing this, one can get a complete assessment of how profitable a company can be in the future. The EM Framework addresses profitability, competition, growth and cost of capital. When factoring in each of these variables, investors can fully assess a company's value.
Below is the list of companies reporting earnings in the first half of the upcoming week along with a closer look at Boston Scientific:
According to the chart below, BSX's intrinsic value is above its current stock price, which leads us to believe that Boston Scientific is undervalued right now.
According to the Wealth Creation chart below, BSX has shown a positive Economic Margin and is forecasted to improve that margin in the upcoming year.
Source: Www.EconomicMargin.com
AFG's Buy/Sell criteria factor in Economic Margin, Management Quality, and AFG's Valuation Metric. In order to determine Management Quality, AFG scores management on their growth decisions in accordance with the company’s ability to either create or destroy wealth. AFG's Valuation Metric measures a company's Percent to Target (the 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.
AFG's default valuation is a good place to start because it is a simple metric that gives a more accurate outlook on a company's value while correcting distortions.
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AFG’s Intrinsic Value Chart identifies how far a stock’s intrinsic value (target price assuming immediate decay) deviates from its trading range, which helps you recognize potentially mispriced stocks and pursue long and short opportunities.
• The blue bars represent the high and low trading range for a stock for 1 year.
• The red dotted line represents AFG’s historical Intrinsic Value through time.
• When the red line (Intrinsic Value) is above the blue bars (trading range), the company looks to be undervalued.
• When the red line (Intrinsic Value) is below the blue bars (trading range), the company looks to be overvalued.
AFG’s Intrinsic Value Chart also contains a company’s Value Score (ranked valuation attractiveness), Economic Margin Change (expected increase/decrease in economic profitability), and Accuracy score (how well AFG’s default valuation has tracked the company).
Wealth Creation Report: displays a company’s Economic Margins (what a company earns above or below its cost of capital) through time as well as a projection of their expected future levels. The second graph shows how a company has grown their assets over time and also contains a projection of how they will grow their assets next year. AFG’s view on wealth creation starts by looking for profitable companies that are also growing their assets to make the most of that profitability.
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.
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